Investor Optimism Abounds L'Oréal S.A. (EPA:OR) But Growth Is Lacking

L'Oréal S.A.'s (EPA:OR) 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 France, where around half of the companies have P/E ratios below 15x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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There hasn't been much to differentiate L'Oréal's and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for L'Oréal

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

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a worthy increase of 3.8%. Pleasingly, EPS has also lifted 46% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 6.9% each year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 13% per year, which is noticeably more attractive.

In light of this, it's alarming that L'Oréal's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Bottom Line On L'Oréal's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that L'Oréal 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for L'Oréal with six simple checks will allow you to discover any risks that could be an issue.

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.