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When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 15x, you may consider Alkane Resources Limited (ASX:ALK) as a stock to avoid entirely with its 33.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Alkane Resources hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.
Does Alkane Resources Have A Relatively High Or Low P/E For Its Industry?
An inspection of average P/E's throughout Alkane Resources' industry may help to explain its particularly high P/E ratio. The image below shows that the Metals and Mining industry as a whole has a P/E ratio lower than the market. So we'd say there is practically no merit in the premise that the company's ratio being shaped by its industry at this time. Some industry P/E's don't move around a lot and right now most companies within the Metals and Mining industry should be getting stifled. Still, the strength of the company's earnings will most likely determine where its P/E shall sit.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Alkane Resources.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Alkane Resources would need to produce outstanding growth well in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 20%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Turning to the outlook, the next three years should generate growth of 13% each year as estimated by the twin analysts watching the company. With the market predicted to deliver 12% growth per annum, the company is positioned for a comparable earnings result.
In light of this, it's curious that Alkane Resources' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
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.
We've established that Alkane Resources currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Alkane Resources (1 shouldn't be ignored) you should be aware of.
Of course, you might also be able to find a better stock than Alkane Resources. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
This article by Simply Wall St is general in nature. 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.
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