Fortescue Ltd's (ASX:FMG) 26% Dip In Price Shows Sentiment Is Matching Earnings

Unfortunately for some shareholders, the Fortescue Ltd (ASX:FMG) share price has dived 26% in the last thirty days, prolonging recent pain. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 16% in that time.

Following the heavy fall in price, Fortescue's price-to-earnings (or "P/E") ratio of 5.9x 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 20x and even P/E's above 37x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Fortescue's negative earnings growth of late has neither been better nor worse than most other companies. It might be that many expect the company's earnings performance to degrade further, which has repressed the P/E. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. At the very least, you'd be hoping that earnings don't fall off a cliff if your plan is to pick up some stock while it's out of favour.

See our latest analysis for Fortescue

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

Is There Any Growth For Fortescue?

In order to justify its P/E ratio, Fortescue would need to produce anemic growth that's substantially trailing the market.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. This isn't what shareholders were looking for as it means they've been left with a 9.4% decline in EPS over the last three years in total. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to slump, contracting by 16% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 17% growth per year, that's a disappointing outcome.

With this information, we are not surprised that Fortescue 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 Key Takeaway

Shares in Fortescue have plummeted and its P/E is now low enough to touch the ground. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Fortescue's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Fortescue (1 shouldn't be ignored!) that you need to be mindful of.

Of course, you might also be able to find a better stock than Fortescue. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.