When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 19x, you may consider Steel Dynamics, Inc. (NASDAQ:STLD) as an attractive investment with its 9.3x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Steel Dynamics has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. 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?

In order to justify its P/E ratio, Steel Dynamics would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 93% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings growth is heading into negative territory, declining 2.2% each year over the next three years. Meanwhile, the broader market is forecast to expand by 10% per year, which paints a poor picture.

With this information, we are not surprised that Steel Dynamics 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Steel Dynamics maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Steel Dynamics that you should be aware of.

If these risks are making you reconsider your opinion on Steel Dynamics, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.