Insufficient Growth At Fortescue Ltd (ASX:FMG) Hampers Share Price

Fortescue Ltd's (ASX:FMG) price-to-earnings (or "P/E") ratio of 7.1x 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 21x 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 highly reduced P/E.

With earnings growth that's superior to most other companies of late, Fortescue has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you 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.

View our latest analysis for Fortescue

Want the full picture on analyst estimates for the company? Then our free report on Fortescue will help you uncover what's on the horizon.

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 an exceptional 18% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 45% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 24% per annum over the next three years. With the market predicted to deliver 19% growth per annum, that's a disappointing outcome.

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.

What We Can Learn From Fortescue's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Fortescue's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. 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 need to take note of risks, for example - Fortescue has 2 warning signs (and 1 which can't be ignored) we think you should know about.

You might be able to find a better investment than Fortescue. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.