Fortescue Metals Group Limited's (ASX:FMG) Price Is Right But Growth Is Lacking

With a price-to-earnings (or "P/E") ratio of 7.7x Fortescue Metals Group Limited (ASX:FMG) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 20x and even P/E's higher than 40x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

Recent times have been pleasing for Fortescue Metals Group as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Fortescue Metals Group

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Want the full picture on analyst estimates for the company? Then our free report on Fortescue Metals Group will help you uncover what's on the horizon.

How Is Fortescue Metals Group's Growth Trending?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Fortescue Metals Group's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 49% last year. The strong recent performance means it was also able to grow EPS by 129% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 22% per annum over the next three years. With the market predicted to deliver 19% growth per annum, that's a disappointing outcome.

With this information, we are not surprised that Fortescue Metals Group is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Fortescue Metals Group's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

You need to take note of risks, for example - Fortescue Metals Group has 2 warning signs (and 1 which is potentially serious) we think you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

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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