Fonterra Co-operative Group Limited (NZSE:FCG) Soars 27% But It's A Story Of Risk Vs Reward

Fonterra Co-operative Group Limited (NZSE:FCG) shares have continued their recent momentum with a 27% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 97%.

In spite of the firm bounce in price, Fonterra Co-operative Group may still be sending very bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 6.1x, since almost half of all companies in New Zealand have P/E ratios greater than 20x and even P/E's higher than 35x 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 limited.

As an illustration, earnings have deteriorated at Fonterra Co-operative Group over the last year, which is not ideal at all. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Fonterra Co-operative Group

Although there are no analyst estimates available for Fonterra Co-operative Group, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Any Growth For Fonterra Co-operative Group?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Fonterra Co-operative Group's to be considered reasonable.

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 5.7%. Still, the latest three year period has seen an excellent 130% 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.

Comparing that to the market, which is only predicted to deliver 22% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

With this information, we find it odd that Fonterra Co-operative Group is trading at a P/E lower than the market. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Bottom Line On Fonterra Co-operative Group's P/E

Fonterra Co-operative Group's recent share price jump still sees its P/E sitting firmly flat on the ground. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Fonterra Co-operative Group revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

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

If you're unsure about the strength of Fonterra Co-operative Group'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.