Insufficient Growth At Drax Group plc (LON:DRX) Hampers Share Price

With a price-to-earnings (or "P/E") ratio of 7x Drax Group plc (LON:DRX) may be sending very bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 17x and even P/E's higher than 28x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

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While the market has experienced earnings growth lately, Drax Group's earnings have gone into reverse gear, which is not great. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If you still like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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Is There Any Growth For Drax Group?

In order to justify its P/E ratio, Drax Group would need to produce anemic growth that's substantially trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 35%. Even so, admirably EPS has lifted 127% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 18% per year during the coming three years according to the eight analysts following the company. Meanwhile, the broader market is forecast to expand by 15% per year, which paints a poor picture.

With this information, we are not surprised that Drax Group 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 Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Drax Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Drax Group (at least 1 which can't be ignored), and understanding them should be part of your investment process.

If you're unsure about the strength of Drax Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.