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It's not a stretch to say that Anglo American Platinum Limited's (JSE:AMS) price-to-earnings (or "P/E") ratio of 7x right now seems quite "middle-of-the-road" compared to the market in South Africa, where the median P/E ratio is around 9x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Anglo American Platinum could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.
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How Is Anglo American Platinum's Growth Trending?
In order to justify its P/E ratio, Anglo American Platinum would need to produce growth that's similar to the market.
Retrospectively, the last year delivered a frustrating 15% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 392% overall rise in EPS, in spite of its unsatisfying short-term performance. 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 8.9% each year during the coming three years according to the nine analysts following the company. With the market predicted to deliver 5.2% growth per year, that's a disappointing outcome.
In light of this, it's somewhat alarming that Anglo American Platinum's P/E sits in line with the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh on the share price eventually.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Anglo American Platinum currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.