Ferguson plc's (NYSE:FERG) Popularity With Investors Is Under Threat From Overpricing

With a price-to-earnings (or "P/E") ratio of 24.4x Ferguson plc (NYSE:FERG) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x 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 as high as it is.

Recent times haven't been advantageous for Ferguson as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Ferguson

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What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Ferguson would need to produce impressive growth in excess of the market.

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 13%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 75% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 11% growth each year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Ferguson's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Ferguson'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.

We've established that Ferguson currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Ferguson you should know about.

Of course, you might also be able to find a better stock than Ferguson. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.