Investors Don't See Light At End Of Magellan Financial Group Limited's (ASX:MFG) Tunnel

Magellan Financial Group Limited's (ASX:MFG) price-to-earnings (or "P/E") ratio of 6.4x might make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 19x and even P/E's above 34x 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.

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With earnings growth that's superior to most other companies of late, Magellan Financial Group has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Magellan Financial Group

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Magellan Financial Group.

How Is Magellan Financial Group's Growth Trending?

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

Retrospectively, the last year delivered a decent 13% gain to the company's bottom line. Still, lamentably EPS has fallen 22% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 12% each year as estimated by the nine analysts watching the company. With the market predicted to deliver 15% growth each year, that's a disappointing outcome.

With this information, we are not surprised that Magellan Financial Group is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Magellan Financial Group's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Magellan Financial Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Magellan Financial Group (of which 1 is significant!) you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.