Zoetis Inc. (NYSE:ZTS) Investors Are Less Pessimistic Than Expected

With a price-to-earnings (or "P/E") ratio of 29.2x Zoetis Inc. (NYSE:ZTS) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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Recent times have been advantageous for Zoetis as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Zoetis' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.7% last year. The solid recent performance means it was also able to grow EPS by 29% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 8.8% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is not materially different.

In light of this, it's curious that Zoetis' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zoetis 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Zoetis that you should be aware of.

If you're unsure about the strength of Zoetis' 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.