Market Still Lacking Some Conviction On Fonterra Co-operative Group Limited (NZSE:FCG)

With a price-to-earnings (or "P/E") ratio of 4.4x Fonterra Co-operative Group Limited (NZSE:FCG) may be sending very bullish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios greater than 21x and even P/E's higher than 36x 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.

For example, consider that Fonterra Co-operative Group's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

View our latest analysis for Fonterra Co-operative Group

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Fonterra Co-operative Group's earnings, revenue and cash flow.

Is There Any Growth For Fonterra Co-operative Group?

The only time you'd be truly comfortable seeing a P/E as depressed as Fonterra Co-operative Group's is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 145% in total over the last three years. 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.

This is in contrast to the rest of the market, which is expected to grow by 12% over the next year, materially lower than the company's recent medium-term annualised growth rates.

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 Final Word

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. 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.

Plus, you should also learn about these 2 warning signs we've spotted with Fonterra Co-operative Group.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.