Investors Don't See Light At End Of Tesco PLC's (LON:TSCO) Tunnel

Tesco PLC's (LON:TSCO) price-to-earnings (or "P/E") ratio of 11.7x might make it look like a buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 16x and even P/E's above 27x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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Tesco certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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How Is Tesco's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Tesco's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 53% last year. The strong recent performance means it was also able to grow EPS by 123% in total over the last three years. 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 1.5% per annum over the next three years. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.

With this information, we can see why Tesco is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Bottom Line On Tesco's P/E

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 Tesco maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Tesco that you should be aware of.

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.