Further Upside For Fonterra Co-operative Group Limited (NZSE:FCG) Shares Could Introduce Price Risks After 32% Bounce

The Fonterra Co-operative Group Limited (NZSE:FCG) share price has done very well over the last month, posting an excellent gain of 32%. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

In spite of the firm bounce in price, Fonterra Co-operative Group's price-to-earnings (or "P/E") ratio of 3.5x might still make it look like a strong buy right now compared to the market in New Zealand, where around half of the companies have P/E ratios above 16x and even P/E's above 31x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Fonterra Co-operative Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. 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.

Check out 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.

Does Growth Match The Low P/E?

Fonterra Co-operative Group's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered an exceptional 71% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 172% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Comparing that to the market, which is only predicted to deliver 23% 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. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

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

Shares in Fonterra Co-operative Group are going to need a lot more upward momentum to get the company's P/E out of its slump. 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 Fonterra Co-operative Group currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.

You should always think about risks. Case in point, we've spotted 2 warning signs for Fonterra Co-operative Group you should be aware of.

If these risks are making you reconsider your opinion on Fonterra Co-operative Group, 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.