Improved Earnings Required Before Grange Resources Limited (ASX:GRR) Shares Find Their Feet

Grange Resources Limited's (ASX:GRR) price-to-earnings (or "P/E") ratio of 5.4x 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 19x and even P/E's above 37x 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.

As an illustration, earnings have deteriorated at Grange Resources over the last year, which is not ideal at all. It might be that many expect the disappointing earnings performance to continue or accelerate, 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.

Check out our latest analysis for Grange Resources

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Grange Resources' earnings, revenue and cash flow.

How Is Grange Resources' Growth Trending?

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

Retrospectively, the last year delivered a frustrating 56% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 11% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 20% shows it's an unpleasant look.

With this information, we are not surprised that Grange Resources 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 Bottom Line On Grange Resources' 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 Grange Resources revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Grange Resources, and understanding them should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.