When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") above 9x, you may consider Sasol Limited (JSE:SOL) as an attractive investment with its 5.4x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
Recent times have been advantageous for Sasol as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.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 low as Sasol's is when the company's growth is on track to lag the market.
If we review the last year of earnings growth, the company posted a terrific increase of 328%. Pleasingly, EPS has also lifted 1,023% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to slump, contracting by 1.2% per annum during the coming three years according to the nine analysts following the company. With the market predicted to deliver 4.7% growth per annum, that's a disappointing outcome.
With this information, we are not surprised that Sasol 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
The Key Takeaway
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.
As we suspected, our examination of Sasol's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. 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.
Before you settle on your opinion, we've discovered 4 warning signs for Sasol (1 makes us a bit uncomfortable!) that you should be aware of.
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.