Investors Don't See Light At End Of Mercury General Corporation's (NYSE:MCY) Tunnel

Mercury General Corporation's (NYSE:MCY) price-to-earnings (or "P/E") ratio of 7x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 32x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Our free stock report includes 2 warning signs investors should be aware of before investing in Mercury General. Read for free now.

With earnings growth that's superior to most other companies of late, Mercury General has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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 Mercury General

Keen to find out how analysts think Mercury General's future stacks up against the industry? In that case, our free report is a great place to start.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 386%. Pleasingly, EPS has also lifted 89% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 100% during the coming year according to the only analyst following the company. That's not great when the rest of the market is expected to grow by 13%.

With this information, we are not surprised that Mercury General is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Mercury General's P/E

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Mercury General 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Mercury General (1 doesn't sit too well with us!) that you need to be mindful of.

Of course, you might also be able to find a better stock than Mercury General. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.