There's No Escaping Fortescue Ltd's (ASX:FMG) Muted Earnings

Fortescue Ltd's (ASX:FMG) price-to-earnings (or "P/E") ratio of 13.6x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 22x and even P/E's above 40x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

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While the market has experienced earnings growth lately, Fortescue'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 this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

See our latest analysis for Fortescue

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Fortescue.

Does Growth Match The Low P/E?

Fortescue's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

Retrospectively, the last year delivered a frustrating 41% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 46% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 6.1% per annum over the next three years. With the market predicted to deliver 17% growth each year, that's a disappointing outcome.

In light of this, it's understandable that Fortescue's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

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.

We've established that Fortescue 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. It's hard to see the share price rising strongly in the near future under these circumstances.

Before you take the next step, you should know about the 3 warning signs for Fortescue (1 is a bit concerning!) that we have uncovered.

Of course, you might also be able to find a better stock than Fortescue. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.