Southstone Minerals Limited's (CVE:SML) Popularity With Investors Is Under Threat From Overpricing

Southstone Minerals Limited's (CVE:SML) price-to-earnings (or "P/E") ratio of 74.5x might make it look like a strong sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 16x and even P/E's below 8x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Southstone Minerals' financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Southstone Minerals

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Southstone Minerals will help you shine a light on its historical performance.

Is There Enough Growth For Southstone Minerals?

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

Retrospectively, the last year delivered a frustrating 57% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that Southstone Minerals 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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Southstone Minerals' 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 Southstone Minerals currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

There are also other vital risk factors to consider and we've discovered 7 warning signs for Southstone Minerals (2 are potentially serious!) that you should be aware of before investing here.

You might be able to find a better investment than Southstone Minerals. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. 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.
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