With a price-to-earnings (or "P/E") ratio of 26.1x The Coca-Cola Company (NYSE:KO) 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 13x and even P/E's lower than 7x 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 lofty.
Recent times have been advantageous for Coca-Cola 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Want the full picture on analyst estimates for the company? Then our free report on Coca-Cola will help you uncover what's on the horizon.
How Is Coca-Cola's Growth Trending?
In order to justify its P/E ratio, Coca-Cola would need to produce outstanding growth well in excess of the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 18% last year. The latest three year period has also seen an excellent 34% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 7.7% 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 9.6% per year, which is not materially different.
In light of this, it's curious that Coca-Cola's 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.
What We Can Learn From Coca-Cola's P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Coca-Cola 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.
There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Coca-Cola that you should be aware of.
Of course, you might also be able to find a better stock than Coca-Cola. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here