Potential Upside For Mount Gibson Iron Limited (ASX:MGX) Not Without Risk

With a price-to-earnings (or "P/E") ratio of 6.3x Mount Gibson Iron Limited (ASX:MGX) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 16x and even P/E's higher than 31x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Mount Gibson Iron certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

See our latest analysis for Mount Gibson Iron

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Mount Gibson Iron's earnings, revenue and cash flow.

How Is Mount Gibson Iron's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 101% last year. The latest three year period has also seen a 10% overall rise in EPS, aided extensively by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to shrink 0.1% in the next 12 months, the company's positive momentum based on recent medium-term earnings results is a bright spot for the moment.

With this information, we find it very odd that Mount Gibson Iron is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

What We Can Learn From Mount Gibson Iron's P/E?

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Mount Gibson Iron revealed its growing earnings over the medium-term aren't contributing to its P/E anywhere near as much as we would have predicted, given the market is set to shrink. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. One major risk is whether its earnings trajectory can keep outperforming under these tough market conditions. At least the risk of a price drop looks to be subdued, but investors think future earnings could see a lot of volatility.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Mount Gibson Iron (1 is concerning) you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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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