Resource Development Group Limited's (ASX:RDG) Low P/E No Reason For Excitement

With a price-to-earnings (or "P/E") ratio of 10.3x Resource Development Group Limited (ASX:RDG) may be sending bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 19x and even P/E's higher than 37x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Resource Development Group certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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What Are Growth Metrics Telling Us About The Low P/E?

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

Retrospectively, the last year delivered an exceptional 285% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 14,088% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the only analyst covering the company suggest earnings growth is heading into negative territory, declining 14% per annum over the next three years. Meanwhile, the broader market is forecast to expand by 17% per annum, which paints a poor picture.

In light of this, it's understandable that Resource Development Group'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.

We've established that Resource Development Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Resource Development Group is showing 4 warning signs in our investment analysis, and 2 of those shouldn't be ignored.

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

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.