Cal-Maine Foods, Inc.'s (NASDAQ:CALM) price-to-earnings (or "P/E") ratio of 10.9x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 32x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings that are retreating more than the market's of late, Cal-Maine Foods has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Cal-Maine Foods' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 64% decrease to the company's bottom line. Even so, admirably EPS has lifted 308% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 44% during the coming year according to the three analysts following the company. Meanwhile, the broader market is forecast to expand by 13%, which paints a poor picture.

With this information, we are not surprised that Cal-Maine Foods is trading at a P/E lower than the market. 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 Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Cal-Maine Foods maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 3 warning signs for Cal-Maine Foods you should be aware of, and 1 of them is significant.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.