Stanmore Resources Limited's (ASX:SMR) Prospects Need A Boost To Lift Shares

With a price-to-earnings (or "P/E") ratio of 2.2x Stanmore Resources Limited (ASX:SMR) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 19x and even P/E's higher than 34x 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.

Stanmore Resources certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you 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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Does Growth Match The Low P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 73%. The latest three year period has also seen an excellent 863% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 34% per annum during the coming three years according to the dual analysts following the company. Meanwhile, the broader market is forecast to expand by 17% per year, which paints a poor picture.

In light of this, it's understandable that Stanmore 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.

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 Stanmore Resources 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Stanmore Resources that you should be aware of.

If you're unsure about the strength of Stanmore Resources' 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.