With a price-to-earnings (or "P/E") ratio of 10.1x Drax Group plc (LON:DRX) may be sending bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 16x and even P/E's higher than 29x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
With earnings that are retreating more than the market's of late, Drax Group has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
View our latest analysis for Drax Group
What Are Growth Metrics Telling Us About The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like Drax Group's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 13%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 35% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 12% per annum, which is noticeably less attractive.
With this information, we find it odd that Drax Group is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.
The Bottom Line On Drax Group's P/E
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Drax Group 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. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.
We don't want to rain on the parade too much, but we did also find 3 warning signs for Drax Group that you need to be mindful of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
About LSE:DRX
Outstanding track record, undervalued and pays a dividend.
