When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Coty Inc. (NYSE:COTY) as a stock to avoid entirely with its 29.7x 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.
Recent times have been advantageous for Coty 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
Check out our latest analysis for Coty
Does Growth Match The High P/E?
In order to justify its P/E ratio, Coty would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered an exceptional 364% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Turning to the outlook, the next three years should generate growth of 12% per annum as estimated by the analysts watching the company. That's shaping up to be similar to the 13% per year growth forecast for the broader market.
In light of this, it's curious that Coty'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. 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 Coty's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
Our examination of Coty'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.
You need to take note of risks, for example - Coty has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.