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Grange Resources Limited's (ASX:GRR) price-to-earnings (or "P/E") ratio of 3.7x might make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 16x and even P/E's above 30x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
For instance, Grange Resources' receding earnings in recent times would have to be some food for thought. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
Does Grange Resources Have A Relatively High Or Low P/E For Its Industry?
It's plausible that Grange Resources' particularly low P/E ratio could be a result of tendencies within its own industry. You'll notice in the figure below that P/E ratios in the Metals and Mining industry are also lower than the market. So this goes some way towards explaining the company's ratio right now. 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. However, what is happening on the company's own income statement is the most important factor to its P/E.
Although there are no analyst estimates available for Grange Resources, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like Grange Resources' to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 31%. The last three years don't look nice either as the company has shrunk EPS by 16% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 0.8% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
In light of this, it's understandable that Grange Resources' P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
What We Can Learn From Grange Resources' P/E?
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
As we suspected, our examination of Grange Resources revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 4 warning signs for Grange Resources you should be aware of, and 1 of them can't be ignored.
You might be able to find a better investment than Grange Resources. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
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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