Fortescue Ltd's (ASX:FMG) Price Is Right But Growth Is Lacking

Fortescue Ltd's (ASX:FMG) price-to-earnings (or "P/E") ratio of 12.4x 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 37x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Fortescue has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for Fortescue

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

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

The only time you'd be truly comfortable seeing a P/E as low as Fortescue's is when the company's growth is on track to lag the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 8.4% each year as estimated by the analysts watching the company. That's not great when the rest of the market is expected to grow by 17% per annum.

With this information, we are not surprised that Fortescue is trading at a P/E lower than the market. 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

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 Fortescue 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. It's hard to see the share price rising strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Fortescue (1 is potentially serious) you should be aware of.

If you're unsure about the strength of Fortescue's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.