The a2 Milk Company Limited's (NZSE:ATM) P/E Is On The Mark

With a price-to-earnings (or "P/E") ratio of 34.4x The a2 Milk Company Limited (NZSE:ATM) may be sending very bearish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios under 19x and even P/E's lower than 11x 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.

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Recent times have been advantageous for a2 Milk as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for a2 Milk

If you'd like to see what analysts are forecasting going forward, you should check out our free report on a2 Milk.

How Is a2 Milk's Growth Trending?

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

If we review the last year of earnings growth, the company posted a worthy increase of 4.2%. This was backed up an excellent period prior to see EPS up by 783% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 20% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 17% each year growth forecast for the broader market.

In light of this, it's understandable that a2 Milk'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.

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.

We've established that a2 Milk maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for a2 Milk with six simple checks on some of these key factors.

If you're unsure about the strength of a2 Milk'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.