Deterra Royalties Limited (ASX:DRR) Looks Inexpensive But Perhaps Not Attractive Enough

Deterra Royalties Limited's (ASX:DRR) price-to-earnings (or "P/E") ratio of 16x might make it look like a 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 36x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

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While the market has experienced earnings growth lately, Deterra Royalties' earnings have gone into reverse gear, which is not great. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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.

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How Is Deterra Royalties' Growth Trending?

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

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 21% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 0.3% each year as estimated by the eleven analysts watching the company. That's not great when the rest of the market is expected to grow by 15% per annum.

In light of this, it's understandable that Deterra Royalties' 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Deterra Royalties 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Deterra Royalties you should be aware of, and 1 of them can't be ignored.

If you're unsure about the strength of Deterra Royalties' 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.