Exxaro Resources Limited (JSE:EXX) Looks Inexpensive But Perhaps Not Attractive Enough

Exxaro Resources Limited's (JSE:EXX) price-to-earnings (or "P/E") ratio of 4.5x might make it look like a strong buy right now compared to the market in South Africa, where around half of the companies have P/E ratios above 11x and even P/E's above 17x 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.

Exxaro Resources could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. 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.

View our latest analysis for Exxaro Resources

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

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

Retrospectively, the last year delivered a frustrating 21% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 1.9% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 5.9% per annum as estimated by the seven analysts watching the company. With the market predicted to deliver 16% growth per year, that's a disappointing outcome.

In light of this, it's understandable that Exxaro Resources' 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 Key Takeaway

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.

As we suspected, our examination of Exxaro Resources' 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. It's hard to see the share price rising strongly in the near future under these circumstances.

Plus, you should also learn about these 2 warning signs we've spotted with Exxaro Resources (including 1 which is a bit concerning).

Of course, you might also be able to find a better stock than Exxaro Resources. 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.