Take Care Before Diving Into The Deep End On Fonterra Co-operative Group Limited (NZSE:FCG)

With a price-to-earnings (or "P/E") ratio of 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 16x and even P/E's higher than 31x are not unusual. 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. It might be that many expect the strong earnings performance to degrade substantially, 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.

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.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Fonterra Co-operative Group would need to produce anemic growth that's substantially trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 100% last year. The latest three year period has also seen an excellent 50% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Comparing that to the market, which is only predicted to deliver 5.4% 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.

What We Can Learn From Fonterra Co-operative Group's P/E?

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.

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. 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 1 warning sign for Fonterra Co-operative Group you should be aware of.

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.