When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 13x, you may consider Zoetis Inc. (NYSE:ZTS) as a stock to avoid entirely with its 33.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's inferior to most other companies of late, Zoetis has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. 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 Zoetis will help you uncover what's on the horizon.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Zoetis' to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 10%. Pleasingly, EPS has also lifted 56% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 12% each year over the next three years. That's shaping up to be materially higher than the 9.7% each year growth forecast for the broader market.
With this information, we can see why Zoetis is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
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.
As we suspected, our examination of Zoetis' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
Having said that, be aware Zoetis is showing 1 warning sign in our investment analysis, you should know about.
You might be able to find a better investment than Zoetis. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
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