With a price-to-earnings (or "P/E") ratio of 22.3x Kellanova (NYSE:K) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Recent times haven't been advantageous for Kellanova as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Kellanova's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 45% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 31% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 21% per year as estimated by the analysts watching the company. With the market only predicted to deliver 10% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Kellanova is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Final Word
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.
We've established that Kellanova maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.
You always need to take note of risks, for example - Kellanova has 3 warning signs we think you should be aware of.
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.