With a price-to-earnings (or "P/E") ratio of 2.8x Danaos Corporation (NYSE:DAC) may be sending very bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 34x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times have been pleasing for Danaos as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, 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.
What Are Growth Metrics Telling Us About The Low P/E?
The only time you'd be truly comfortable seeing a P/E as depressed as Danaos' is when the company's growth is on track to lag the market decidedly.
Taking a look back first, we see that the company grew earnings per share by an impressive 17% last year. Still, incredibly EPS has fallen 16% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to slump, contracting by 14% per annum during the coming three years according to the two analysts following the company. That's not great when the rest of the market is expected to grow by 10% per annum.
In light of this, it's understandable that Danaos' 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 Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Danaos' 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.
You need to take note of risks, for example - Danaos has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.
