Compass Group PLC's (LON:CPG) Share Price Matching Investor Opinion

With a price-to-earnings (or "P/E") ratio of 40.6x Compass Group PLC (LON:CPG) may be sending very bearish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios under 15x and even P/E's lower than 9x are not unusual. 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.

While the market has experienced earnings growth lately, Compass Group's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for Compass Group

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Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 11% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 207% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 23% per year over the next three years. That's shaping up to be materially higher than the 13% per annum growth forecast for the broader market.

In light of this, it's understandable that Compass Group's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Compass Group's P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Compass Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Compass Group you should know about.

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

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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.