With The a2 Milk Company Limited (NZSE:ATM) It Looks Like You'll Get What You Pay For

With a price-to-earnings (or "P/E") ratio of 32.7x 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 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly 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. 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.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like a2 Milk's to be considered reasonable.

Retrospectively, the last year delivered a decent 4.2% gain to the company's bottom line. The latest three year period has also seen an excellent 783% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 21% per annum during the coming three years according to the analysts following the company. With the market only predicted to deliver 19% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that a2 Milk's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From a2 Milk's P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of a2 Milk's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Before you take the next step, you should know about the 1 warning sign for a2 Milk that we have uncovered.

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.