The a2 Milk Company Limited's (NZSE:ATM) Price Is Out Of Tune With Earnings

With a price-to-earnings (or "P/E") ratio of 36.3x The a2 Milk Company Limited (NZSE:ATM) may be sending very bearish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios under 18x 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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There hasn't been much to differentiate a2 Milk's and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for a2 Milk

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Is There Enough Growth For a2 Milk?

a2 Milk's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 21% last year. The strong recent performance means it was also able to grow EPS by 70% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 14% per year during the coming three years according to the analysts following the company. That's shaping up to be similar to the 14% each year growth forecast for the broader market.

With this information, we find it interesting that a2 Milk is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From a2 Milk's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of a2 Milk's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with a2 Milk.

You might be able to find a better investment than a2 Milk. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.