There's Reason For Concern Over Wesfarmers Limited's (ASX:WES) Price

With a price-to-earnings (or "P/E") ratio of 35.6x Wesfarmers Limited (ASX:WES) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 21x and even P/E's lower than 12x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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Recent times have been advantageous for Wesfarmers 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.

View our latest analysis for Wesfarmers

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

How Is Wesfarmers' Growth Trending?

Wesfarmers' 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.

If we review the last year of earnings growth, the company posted a worthy increase of 14%. The solid recent performance means it was also able to grow EPS by 24% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 5.4% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 19% per year, which is noticeably more attractive.

In light of this, it's alarming that Wesfarmers' 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. 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.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Wesfarmers you should be aware of.

You might be able to find a better investment than Wesfarmers. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.