Energy Resources of Australia Ltd (ASX:ERA) May Have Run Too Fast Too Soon With Recent 26% Price Plummet

Energy Resources of Australia Ltd (ASX:ERA) shares have retraced a considerable 26% in the last month, reversing a fair amount of their solid recent performance. Longer-term, the stock has been solid despite a difficult 30 days, gaining 25% in the last year.

Even after such a large drop in price, Energy Resources of Australia's price-to-earnings (or "P/E") ratio of 64.4x might still make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 23x and even P/E's below 13x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Energy Resources of Australia over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Energy Resources of Australia

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Although there are no analyst estimates available for Energy Resources of Australia, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Energy Resources of Australia's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Energy Resources of Australia's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 74% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the market, which is expected to grow by 30% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Energy Resources of Australia is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From Energy Resources of Australia's P/E?

Even after such a strong price drop, Energy Resources of Australia's P/E still exceeds the rest of the market significantly. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Energy Resources of Australia currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 2 warning signs for Energy Resources of Australia you should be aware of, and 1 of them is concerning.

You might be able to find a better investment than Energy Resources of Australia. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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