Unpleasant Surprises Could Be In Store For Tesco PLC's (LON:TSCO) Shares

It's not a stretch to say that Tesco PLC's (LON:TSCO) price-to-earnings (or "P/E") ratio of 13.7x right now seems quite "middle-of-the-road" compared to the market in the United Kingdom, where the median P/E ratio is around 15x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been pleasing for Tesco as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. 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 not quite in favour.

View our latest analysis for Tesco

Want the full picture on analyst estimates for the company? Then our free report on Tesco will help you uncover what's on the horizon.

Does Growth Match The P/E?

Tesco's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

If we review the last year of earnings growth, the company posted a terrific increase of 59%. The strong recent performance means it was also able to grow EPS by 89% in total over the last three years. 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 8.9% per annum as estimated by the twelve analysts watching the company. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

In light of this, it's curious that Tesco's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Tesco's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 1 warning sign for Tesco that you need to take into consideration.

If you're unsure about the strength of Tesco's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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

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.