Improved Earnings Required Before Orica Limited (ASX:ORI) Shares Find Their Feet

With a price-to-earnings (or "P/E") ratio of 17.1x Orica Limited (ASX:ORI) may be sending bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 20x and even P/E's higher than 38x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been advantageous for Orica as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Orica

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How Is Orica's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 82% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Looking ahead now, EPS is anticipated to climb by 5.8% each year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 18% each year growth forecast for the broader market.

With this information, we can see why Orica is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

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

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Orica's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Orica that you need to be mindful of.

If these risks are making you reconsider your opinion on Orica, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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