Cautious Investors Not Rewarding Shell plc's (LON:SHEL) Performance Completely

Shell plc's (LON:SHEL) price-to-earnings (or "P/E") ratio of 12.1x might make it look like a buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 16x and even P/E's above 28x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Shell hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.

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What Are Growth Metrics Telling Us About The Low P/E?

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

Retrospectively, the last year delivered a frustrating 43% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 323% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 17% each year over the next three years. With the market only predicted to deliver 14% per year, the company is positioned for a stronger earnings result.

With this information, we find it odd that Shell is trading at a P/E lower than the market. It looks like most investors are not convinced at all that the company can achieve future growth expectations.

The Bottom Line On Shell's P/E

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.

We've established that Shell currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Having said that, be aware Shell is showing 2 warning signs in our investment analysis, you should know about.

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