Forterra plc’s (LON:FORT) price-to-earnings (or “P/E”) ratio of 6.7x might make it look like a strong buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 18x and even P/E’s above 36x are quite common. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
With earnings that are retreating more than the market’s of late, Forterra has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. You’d much rather the company wasn’t bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
Check out our latest analysis for Forterra
Is There Any Growth For Forterra?
In order to justify its P/E ratio, Forterra would need to produce anemic growth that’s substantially trailing the market.
Taking a look back first, the company’s earnings per share growth last year wasn’t something to get excited about as it posted a disappointing decline of 10%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 73% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 13% per year as estimated by the nine analysts watching the company. With the market predicted to deliver 13% growth each year, that’s a disappointing outcome.
In light of this, it’s understandable that Forterra’s P/E would sit below the majority of other companies. 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 Key Takeaway
It’s argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Forterra’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.
It’s always necessary to consider the ever-present spectre of investment risk. We’ve identified 4 warning signs with Forterra (at least 1 which is significant), and understanding these should be part of your investment process.
If you’re unsure about the strength of Forterra’s business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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