Magellan Financial Group Limited's (ASX:MFG) 26% Dip In Price Shows Sentiment Is Matching Earnings

Magellan Financial Group Limited (ASX:MFG) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. Indeed, the recent drop has reduced its annual gain to a relatively sedate 4.3% over the last twelve months.

Following the heavy fall in price, given about half the companies in Australia have price-to-earnings ratios (or "P/E's") above 19x, you may consider Magellan Financial Group as a highly attractive investment with its 7x P/E ratio. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Magellan Financial Group as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, 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.

See our latest analysis for Magellan Financial Group

Keen to find out how analysts think Magellan Financial Group's future stacks up against the industry? In that case, our free report is a great place to start.

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

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 25% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings growth is heading into negative territory, declining 14% each year over the next three years. With the market predicted to deliver 17% 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.

The Final Word

Magellan Financial Group's P/E looks about as weak as its stock price lately. 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.

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.

Plus, you should also learn about these 2 warning signs we've spotted with Magellan Financial Group (including 1 which is significant).

If you're unsure about the strength of Magellan Financial Group'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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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.