With a price-to-earnings (or "P/E") ratio of 18.9x Canadian National Railway Company (TSE:CNR) may be sending bearish signals at the moment, given that almost half of all companies in Canada have P/E ratios under 14x and even P/E's lower than 7x 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 as high as it is.
While the market has experienced earnings growth lately, Canadian National Railway's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.
See our latest analysis for Canadian National Railway
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Canadian National Railway's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 18% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 12% each year over the next three years. That's shaping up to be similar to the 13% each year growth forecast for the broader market.
In light of this, it's curious that Canadian National Railway's P/E sits above the majority of other companies. 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.
What We Can Learn From Canadian National Railway's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Canadian National Railway currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Canadian National Railway, and understanding should be part of your investment process.
Of course, you might also be able to find a better stock than Canadian National Railway. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Valuation is complex, but we're here to simplify it.
Discover if Canadian National Railway might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.