There's Reason For Concern Over Compass Group PLC's (LON:CPG) Price
Compass Group PLC's (LON:CPG) price-to-earnings (or "P/E") ratio of 29.2x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 15x and even P/E's below 10x are quite common. 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 Compass Group as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Compass Group
How Is Compass Group's Growth Trending?
In order to justify its P/E ratio, Compass Group would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings growth, the company posted a terrific increase of 34%. The latest three year period has also seen an excellent 58% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 16% each year over the next three years. That's shaping up to be similar to the 15% per annum growth forecast for the broader market.
In light of this, it's curious that Compass Group'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 Compass Group's P/E?
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
Our examination of Compass Group's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Compass Group you should know about.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.