Canadian National Railway Company's (TSE:CNR) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 14x, you may consider Canadian National Railway Company (TSE:CNR) as a stock to potentially avoid with its 17x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been advantageous for Canadian National Railway as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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How Is Canadian National Railway's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Canadian National Railway's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 15% last year. As a result, it also grew EPS by 30% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Looking ahead now, EPS is anticipated to climb by 5.6% 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 8.4% each year, which is noticeably more attractive.

In light of this, it's alarming that Canadian National Railway's 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. 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.

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.

We've established that Canadian National Railway currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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 1 warning sign for Canadian National Railway you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.