Some Shareholders Feeling Restless Over Wesfarmers Limited's (ASX:WES) P/E Ratio

Wesfarmers Limited's (ASX:WES) price-to-earnings (or "P/E") ratio of 30.9x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Wesfarmers' negative earnings growth of late has neither been better nor worse than most other companies. It might be that many expect the company's earnings to strengthen positively despite the tough market conditions, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for Wesfarmers

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

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Wesfarmers' is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Although pleasingly EPS has lifted 33% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 9.6% per year as estimated by the analysts watching the company. With the market predicted to deliver 16% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Wesfarmers' P/E sits above the majority of other companies. 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 Wesfarmers' P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Wesfarmers' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Wesfarmers you should know about.

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).

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

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.