Lynas Rare Earths Limited's (ASX:LYC) price-to-earnings (or "P/E") ratio of 76.3x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Lynas Rare Earths hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Lynas Rare Earths

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

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Lynas Rare Earths' is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 73%. As a result, earnings from three years ago have also fallen 50% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 94% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 19% per year growth forecast for the broader market.

With this information, we can see why Lynas Rare Earths is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

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.

As we suspected, our examination of Lynas Rare Earths' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

You need to take note of risks, for example - Lynas Rare Earths has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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