Drax Group plc (LON:DRX) Surges 31% Yet Its Low P/E Is No Reason For Excitement

Drax Group plc (LON:DRX) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 6.7% isn't as impressive.

Even after such a large jump in price, Drax Group's price-to-earnings (or "P/E") ratio of 3.8x might still make it look like a strong buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 17x and even P/E's above 31x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Drax Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Drax Group

Want the full picture on analyst estimates for the company? Then our free report on Drax Group will help you uncover what's on the horizon.

How Is Drax Group's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 269% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings growth is heading into negative territory, declining 20% per annum over the next three years. That's not great when the rest of the market is expected to grow by 15% per annum.

In light of this, it's understandable that Drax Group's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Bottom Line On Drax Group's P/E

Even after such a strong price move, Drax Group's P/E still trails the rest of the market significantly. 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.

As we suspected, our examination of Drax Group's 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Drax Group (1 is concerning!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.

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