Meritor, Inc.'s (NYSE:MTOR) price-to-earnings (or "P/E") ratio of 6.5x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 19x and even P/E's above 38x are quite common. 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.
Recent times have been pleasing for Meritor 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.
See our latest analysis for Meritor
Keen to find out how analysts think Meritor's future stacks up against the industry? In that case, our free report is a great place to start.
Is There Any Growth For Meritor?
There's an inherent assumption that a company should far underperform the market for P/E ratios like Meritor's to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 12%. Still, lamentably EPS has fallen 42% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 5.0% each year as estimated by the three analysts watching the company. That's shaping up to be materially lower than the 13% per year growth forecast for the broader market.
With this information, we can see why Meritor is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.
The Final Word
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Meritor's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. 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.
Having said that, be aware Meritor is showing 4 warning signs in our investment analysis, you should know about.