Getting In Cheap On Champion Iron Limited (ASX:CIA) Might Be Difficult

Champion Iron Limited's (ASX:CIA) price-to-earnings (or "P/E") ratio of 26.8x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 20x and even P/E's below 11x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

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Champion Iron could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Champion Iron

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

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

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

Retrospectively, the last year delivered a frustrating 72% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 76% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 38% each year as estimated by the twelve analysts watching the company. That's shaping up to be materially higher than the 17% each year growth forecast for the broader market.

In light of this, it's understandable that Champion Iron's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Champion 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.

We've established that Champion Iron maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

You should always think about risks. Case in point, we've spotted 2 warning signs for Champion Iron you should be aware of, and 1 of them makes us a bit uncomfortable.

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.