Bayer CropScience Limited's (NSE:BAYERCROP) Shares May Have Run Too Fast Too Soon

Bayer CropScience Limited's (NSE:BAYERCROP) price-to-earnings (or "P/E") ratio of 37.9x might make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 30x and even P/E's below 17x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Bayer CropScience hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.

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Is There Enough Growth For Bayer CropScience?

The only time you'd be truly comfortable seeing a P/E as high as Bayer CropScience's is when the company's growth is on track to outshine the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 31%. Still, the latest three year period has seen an excellent 37% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 19% per annum over the next three years. That's shaping up to be similar to the 19% each year growth forecast for the broader market.

With this information, we find it interesting that Bayer CropScience is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Bayer CropScience currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Bayer CropScience you should know about.

Of course, you might also be able to find a better stock than Bayer CropScience. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.