African Rainbow Minerals Limited's (JSE:ARI) Business Is Yet to Catch Up With Its Share Price

With a price-to-earnings (or "P/E") ratio of 11.8x African Rainbow Minerals Limited (JSE:ARI) may be sending bearish signals at the moment, given that almost half of all companies in South Africa have P/E ratios under 8x and even P/E's lower than 5x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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While the market has experienced earnings growth lately, African Rainbow Minerals' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for African Rainbow Minerals

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

How Is African Rainbow Minerals' Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like African Rainbow Minerals' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 32%. As a result, earnings from three years ago have also fallen 72% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 8.9% each year during the coming three years according to the five analysts following the company. That's shaping up to be materially lower than the 14% per year growth forecast for the broader market.

In light of this, it's alarming that African Rainbow Minerals' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From African Rainbow Minerals' P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that African Rainbow Minerals currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for African Rainbow Minerals that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.