With a price-to-earnings (or "P/E") ratio of 35.5x Zoetis Inc. (NYSE:ZTS) 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 14x and even P/E's lower than 8x 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.
Zoetis could be doing better as it's been growing earnings less than most other companies lately. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. 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.
Is There Enough Growth For Zoetis?
In order to justify its P/E ratio, Zoetis would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a decent 5.2% gain to the company's bottom line. The latest three year period has also seen an excellent 45% overall rise in EPS, aided somewhat 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 eleven analysts covering the company suggest earnings should grow by 10% per year over the next three years. That's shaping up to be similar to the 9.1% per annum growth forecast for the broader market.
With this information, we find it interesting that Zoetis is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Final Word
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Zoetis 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.
Before you take the next step, you should know about the 1 warning sign for Zoetis that we have uncovered.
If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.
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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.
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