Unpleasant Surprises Could Be In Store For Canadian Pacific Railway Limited's (TSE:CP) Shares

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 13x, you may consider Canadian Pacific Railway Limited (TSE:CP) as a stock to potentially avoid with its 19.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Canadian Pacific Railway as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Canadian Pacific Railway

Does Canadian Pacific Railway Have A Relatively High Or Low P/E For Its Industry?

It's plausible that Canadian Pacific Railway's high P/E ratio could be a result of tendencies within its own industry. You'll notice in the figure below that P/E ratios in the Transportation industry are also higher than the market. So we'd say there is merit in the premise that the company's ratio being shaped by its industry at this time. In the context of the Transportation industry's current setting, most of its constituents' P/E's would be expected to be raised up. Ultimately though, it's going to be the fundamentals of the business like earnings and growth that count most.

Keen to find out how analysts think Canadian Pacific Railway's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The High P/E?

Canadian Pacific Railway's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 22% last year. The latest three year period has also seen an excellent 74% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 3.9% per year over the next three years. That's shaping up to be materially lower than the 22% per year growth forecast for the broader market.

In light of this, it's alarming that Canadian Pacific Railway's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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.

Our examination of Canadian Pacific Railway's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 1 warning sign for Canadian Pacific Railway that you should be aware of.

If you're unsure about the strength of Canadian Pacific Railway's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. 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.
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