Iluka Resources Limited (ASX:ILU) shares have continued their recent momentum with a 30% gain in the last month alone. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 27% in the last twelve months.
Although its price has surged higher, given about half the companies in Australia have price-to-earnings ratios (or "P/E's") above 19x, you may still consider Iluka Resources as a highly attractive investment with its 9.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
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Iluka Resources hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.
See our latest analysis for Iluka Resources
In order to justify its P/E ratio, Iluka Resources 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 33%. The last three years don't look nice either as the company has shrunk EPS by 36% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to slump, contracting by 6.1% per year during the coming three years according to the eight analysts following the company. With the market predicted to deliver 15% growth each year, that's a disappointing outcome.
In light of this, it's understandable that Iluka 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.
Iluka Resources' recent share price jump still sees its P/E sitting firmly flat on the ground. 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.
As we suspected, our examination of Iluka Resources' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Iluka Resources you should know about.
If these risks are making you reconsider your opinion on Iluka Resources, explore our interactive list of high quality stocks to get an idea of what else is out there.
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