Investor Optimism Abounds Coles Group Limited (ASX:COL) But Growth Is Lacking

With a price-to-earnings (or "P/E") ratio of 22.7x Coles Group Limited (ASX:COL) may be sending bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 18x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Coles Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Coles Group's Growth Trending?

In order to justify its P/E ratio, Coles Group would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 8.4% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 2.8% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 9.4% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 18% per year, 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

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.

It is also worth noting that we have found 1 warning sign for Coles Group that you need to take into consideration.

If these risks are making you reconsider your opinion on Coles Group, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com