L'Oréal S.A.'s (EPA:OR) Popularity With Investors Is Under Threat From Overpricing

L'Oréal S.A.'s (EPA:OR) price-to-earnings (or "P/E") ratio of 34.6x 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 8x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

L'Oréal certainly has been doing a good job lately as it's been growing earnings more 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.

Check out 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.

Is There Enough Growth For L'Oréal?

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.

Retrospectively, the last year delivered a decent 8.5% gain to the company's bottom line. Pleasingly, EPS has also lifted 81% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.0% per year over the next three years. With the market predicted to deliver 14% growth each year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that L'Oréal is trading at a P/E higher than the market. 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

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 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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com