There's No Escaping West African Resources Limited's (ASX:WAF) Muted Earnings

With a price-to-earnings (or "P/E") ratio of 7.1x West African Resources Limited (ASX:WAF) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 15x and even P/E's higher than 30x are not unusual. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, West African Resources has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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 West African Resources

If you'd like to see what analysts are forecasting going forward, you should check out our free report on West African 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 West African Resources' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 105%. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 24% per annum as estimated by the dual analysts watching the company. Meanwhile, the broader market is forecast to expand by 12% per year, which paints a poor picture.

With this information, we are not surprised that West African 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.

What We Can Learn From West African Resources' P/E?

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of West African 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. 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 West African Resources that you need to be mindful of.

If you're unsure about the strength of West African Resources' 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.