L'Oréal S.A.'s (EPA:OR) Share Price Could Signal Some Risk

When close to half the companies in France have price-to-earnings ratios (or "P/E's") below 15x, you may consider L'Oréal S.A. (EPA:OR) as a stock to avoid entirely with its 36.4x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

L'Oréal certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. 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.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, L'Oréal would need to produce outstanding growth well in excess of the market.

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. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 8.6% per year during the coming three years according to the analysts following the company. With the market predicted to deliver 14% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's alarming that L'Oréal'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 Bottom Line On L'Oréal's P/E

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 L'Oréal currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for L'Oréal with six simple checks.

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.