Some Confidence Is Lacking In Merck KGaA's (ETR:MRK) P/E

Merck KGaA's (ETR:MRK) price-to-earnings (or "P/E") ratio of 24x might make it look like a sell right now compared to the market in Germany, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Merck KGaA'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.

See our latest analysis for Merck KGaA

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

Does Growth Match The High P/E?

In order to justify its P/E ratio, Merck KGaA would need to produce impressive growth in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 16%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 19% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 14% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 13% per annum, which is not materially different.

In light of this, it's curious that Merck KGaA'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. 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 Merck KGaA's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Merck KGaA's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Merck KGaA with six simple checks.

Of course, you might also be able to find a better stock than Merck KGaA. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

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