Getting In Cheap On African Rainbow Minerals Limited (JSE:ARI) Is Unlikely

There wouldn't be many who think African Rainbow Minerals Limited's (JSE:ARI) price-to-earnings (or "P/E") ratio of 9.4x is worth a mention when the median P/E in South Africa is similar at about 8x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

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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. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

View our latest analysis for African Rainbow Minerals

If you'd like to see what analysts are forecasting going forward, you should check out our free report on African Rainbow Minerals.

How Is African Rainbow Minerals' Growth Trending?

The only time you'd be comfortable seeing a P/E like African Rainbow Minerals' is when the company's growth is tracking the market closely.

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 8.8% 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 13% per annum growth forecast for the broader market.

With this information, we find it interesting that African Rainbow Minerals is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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

Before you take the next step, you should know about the 2 warning signs for African Rainbow Minerals that we have uncovered.

If these risks are making you reconsider your opinion on African Rainbow Minerals, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.