Stanmore Resources Limited's (ASX:SMR) Business And Shares Still Trailing The Market

Stanmore Resources Limited's (ASX:SMR) price-to-earnings (or "P/E") ratio of 7x 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 20x and even P/E's above 37x 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.

Stanmore Resources could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for Stanmore Resources

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Stanmore Resources.

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 Stanmore Resources' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 66% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Shifting to the future, estimates from the four analysts covering the company suggest earnings growth is heading into negative territory, declining 18% per annum over the next three years. That's not great when the rest of the market is expected to grow by 18% per annum.

In light of this, it's understandable that Stanmore Resources' P/E would sit below the majority of other companies. 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 Final Word

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 Stanmore Resources' 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 - Stanmore Resources has 3 warning signs (and 1 which is potentially serious) we think you should know about.

Of course, you might also be able to find a better stock than Stanmore Resources. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.