Some Confidence Is Lacking In The a2 Milk Company Limited's (NZSE:ATM) P/E

The a2 Milk Company Limited's (NZSE:ATM) price-to-earnings (or "P/E") ratio of 21.4x might make it look like a sell right now compared to the market in New Zealand, where around half of the companies have P/E ratios below 15x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

a2 Milk certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for a2 Milk

Keen to find out how analysts think a2 Milk's future stacks up against the industry? In that case, our free report is a great place to start.

How Is a2 Milk's Growth Trending?

In order to justify its P/E ratio, a2 Milk would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 29%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 59% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 16% per year as estimated by the analysts watching the company. With the market predicted to deliver 21% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that a2 Milk's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

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.

Our examination of a2 Milk's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near 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 high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for a2 Milk with six simple checks.

If these risks are making you reconsider your opinion on a2 Milk, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.