Cochlear Limited's (ASX:COH) Shares May Have Run Too Fast Too Soon

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may consider Cochlear Limited (ASX:COH) as a stock to avoid entirely with its 53x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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There hasn't been much to differentiate Cochlear's and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Cochlear

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

Does Growth Match The High P/E?

Cochlear's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a decent 6.1% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 45% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 15% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is not materially different.

With this information, we find it interesting that Cochlear is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Cochlear'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.

Our examination of Cochlear's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Cochlear with six simple checks on some of these key factors.

If you're unsure about the strength of Cochlear'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. 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.