Telstra Group Limited's (ASX:TLS) Price Is Out Of Tune With Earnings

Telstra Group Limited's (ASX:TLS) price-to-earnings (or "P/E") ratio of 31.2x 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 17x 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.

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While the market has experienced earnings growth lately, Telstra Group's earnings have gone into reverse gear, which is not great. 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.

Check out our latest analysis for Telstra Group

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

What Are Growth Metrics Telling Us About The High P/E?

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

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 20% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 16% per year during the coming three years according to the twelve analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15% each year, which is not materially different.

With this information, we find it interesting that Telstra Group 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. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Telstra 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 Telstra Group currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

You need to take note of risks, for example - Telstra Group has 3 warning signs (and 1 which is potentially serious) we think 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).

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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.