Unpleasant Surprises Could Be In Store For Union Pacific Corporation's (NYSE:UNP) Shares

Union Pacific Corporation's (NYSE:UNP) price-to-earnings (or "P/E") ratio of 20.9x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Union Pacific certainly has been doing a good job lately as it's been growing earnings more 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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Is There Enough Growth For Union Pacific?

There's an inherent assumption that a company should outperform the market for P/E ratios like Union Pacific's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 6.0%. The solid recent performance means it was also able to grow EPS by 12% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.5% per annum over the next three years. With the market predicted to deliver 11% growth per annum, the company is positioned for a comparable earnings result.

In light of this, it's curious that Union Pacific'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.

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 Union Pacific 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Union Pacific you should be aware of.

If these risks are making you reconsider your opinion on Union Pacific, 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.