Risks To Shareholder Returns Are Elevated At These Prices For Associated British Foods plc (LON:ABF)

With a median price-to-earnings (or "P/E") ratio of close to 16x in the United Kingdom, you could be forgiven for feeling indifferent about Associated British Foods plc's (LON:ABF) P/E ratio of 15.6x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

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While the market has experienced earnings growth lately, Associated British Foods' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is moderate because investors think this poor earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

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If you'd like to see what analysts are forecasting going forward, you should check out our free report on Associated British Foods.

How Is Associated British Foods' Growth Trending?

In order to justify its P/E ratio, Associated British Foods would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. Even so, admirably EPS has lifted 62% in aggregate from three years ago, notwithstanding the last 12 months. 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.

Turning to the outlook, the next three years should generate growth of 13% each year as estimated by the analysts watching the company. With the market predicted to deliver 17% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's curious that Associated British Foods' 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 Key Takeaway

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.

We've established that Associated British Foods currently trades on a 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 moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Associated British Foods, and understanding should be part of your investment process.

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.