The Market Doesn't Like What It Sees From Exxaro Resources Limited's (JSE:EXX) Earnings Yet

When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") above 9x, you may consider Exxaro Resources Limited (JSE:EXX) as a highly attractive investment with its 3.3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Recent times have been advantageous for Exxaro Resources as its earnings have been rising faster than most other companies. 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 Exxaro Resources

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

Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 26% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 87% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 13% each year as estimated by the eight analysts watching the company. That's not great when the rest of the market is expected to grow by 12% per annum.

With this information, we are not surprised that Exxaro Resources 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 Final Word

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 Exxaro Resources maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 2 warning signs for Exxaro Resources you should be aware of, and 1 of them doesn't sit too well with us.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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.