Mount Gibson Iron Limited's (ASX:MGX) Popularity With Investors Is Under Threat From Overpricing

With a price-to-earnings (or "P/E") ratio of 63.4x Mount Gibson Iron Limited (ASX:MGX) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Earnings have risen firmly for Mount Gibson Iron recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Mount Gibson Iron

Although there are no analyst estimates available for Mount Gibson Iron, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Growth For Mount Gibson Iron?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 24% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 90% drop in EPS in aggregate. 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 26% shows it's an unpleasant look.

With this information, we find it concerning that Mount Gibson Iron is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On Mount Gibson Iron's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Mount Gibson Iron currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Mount Gibson Iron with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Mount Gibson Iron. 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.