Coles Group Limited (ASX:COL) Investors Are Less Pessimistic Than Expected

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 20x, you may consider Coles Group Limited (ASX:COL) as a stock to potentially avoid with its 29.2x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Coles Group could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Coles Group

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Coles Group.

Is There Enough Growth For Coles Group?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 4.4%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 10% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 17% per annum, which is noticeably more attractive.

With this information, we find it concerning that Coles Group is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

What We Can Learn From Coles Group's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Coles Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Coles Group with six simple checks will allow you to discover any risks that could be an issue.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.