The Market Doesn't Like What It Sees From Headwater Exploration Inc.'s (TSE:HWX) Earnings Yet

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") above 17x, you may consider Headwater Exploration Inc. (TSE:HWX) as an attractive investment with its 8.3x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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Headwater Exploration certainly has been doing a good job lately as it's been growing earnings more than most other companies. 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.

View our latest analysis for Headwater Exploration

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Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. The latest three year period has also seen an excellent 72% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 14% each year during the coming three years according to the four analysts following the company. With the market predicted to deliver 10% growth per year, that's a disappointing outcome.

In light of this, it's understandable that Headwater Exploration's 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.

What We Can Learn From Headwater Exploration'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 Headwater Exploration maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. 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.

Plus, you should also learn about these 2 warning signs we've spotted with Headwater Exploration (including 1 which can't be ignored).

If these risks are making you reconsider your opinion on Headwater Exploration, 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.