Little Excitement Around Fortescue Ltd's (ASX:FMG) Earnings

Fortescue Ltd's (ASX:FMG) price-to-earnings (or "P/E") ratio of 6.8x 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 17x and even P/E's above 29x 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.

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While the market has experienced earnings growth lately, Fortescue's earnings have gone into reverse gear, which is not great. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. 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.

Check out 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.

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

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

Retrospectively, the last year delivered a frustrating 32% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 57% overall. 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% each year during the coming three years according to the analysts following the company. With the market predicted to deliver 15% 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. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. 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?

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.

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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Fortescue (1 shouldn't be ignored) 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.

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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.