The price-to-earnings ratio (P/E) is a tool many investors use to work out the relative value of a stock. In theory, the lower the ratio is, the more undervalued the company could be. Yet if the ratio is exceptionally low, it could mean that investors simply don’t want to own the stock! So when I spotted this FTSE 250 stock with a ratio of just 2.62, I thought it was worth investigating further.
Why the P/E ratio is so low
The company I’m referring to is Ferrexpo (LSE:FXPO). The commodity stock is the third-largest exporter of iron ore pellets in the world. It operates out of central Ukraine.
Over the past year, the share price is down by 49%. In fact, earlier in September the stock hit fresh 52-week lows at 72p. When I consider the low P/E ratio, the fall in the share price is a clear factor that has pushed the ratio down over the course of this year.
The other element to the ratio is earnings. It’s true these have also been falling. For example, the profit after tax for 2022 was the worst figure in over five years. An investor might conclude that if both the share price and earnings are falling, the ratio shouldn’t also decrease. For example, if earnings fall by 10% and the share price drops by 10%, in theory the P/E ratio won’t change.
For Ferrexpo, the fall in the share price is greater than the impact of lower earnings. This means that the ratio has fallen to such a low level despite the drop in profits.
Taking into account fundamentals
I don’t believe an investor should make a decision purely based on the ratio and nothing else. It’s key to evaluate where the business could be in the future.
In August, the company released half-year results. The negative impact of the ongoing war in Ukraine is still being felt. The firm is struggling with the closure of Ukrainian ports and on getting production facilities up to full scale again.
That being said, production in H1 2023 was up 57% from H2 2022, with revenue also up 7%. However, it remains down significantly from pre-war levels.
Until the war ends and the business can get back to operating freely, I struggle to see how earnings will materially improve. Granted, this isn’t the fault of the management team, but the external impact of the war is too great to ignore as an investor.
Making a decision
Based purely on the P/E ratio, I’d consider buying the stock. But after having taken into account the reason for the low ratio, I don’t feel comfortable buying at the moment. In the future, I feel this could be a great mining stock to have in a portfolio. Yet given the unknown risk of how long the war will continue, I can’t see the share price moving higher until there’s more clarity.
