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Why Lundin Mining Corporation's (TSE:LUN) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Lundin Mining Corporation's (TSE:LUN), to help you decide if the stock is worth further research. Lundin Mining has a price to earnings ratio of 20.94, based on the last twelve months. That means that at current prices, buyers pay CA$20.94 for every CA$1 in trailing yearly profits.

Check out our latest analysis for Lundin Mining

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Lundin Mining:

P/E of 20.94 = $4.75 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.23 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Lundin Mining saw earnings per share decrease by 58% last year. But over the longer term (5 years) earnings per share have increased by 5.8%.

Does Lundin Mining Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Lundin Mining has a higher P/E than the average company (13.8) in the metals and mining industry.

TSX:LUN Price Estimation Relative to Market, June 10th 2019

Lundin Mining's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Lundin Mining's Debt Impact Its P/E Ratio?

With net cash of US$700m, Lundin Mining has a very strong balance sheet, which may be important for its business. Having said that, at 20% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Lundin Mining's P/E Ratio

Lundin Mining's P/E is 20.9 which is above average (15) in the CA market. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Lundin Mining may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.