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The Estée Lauder Companies Inc.'s (NYSE:EL) price-to-earnings (or "P/E") ratio of 39.3x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 14x and even P/E's below 8x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Estée Lauder Companies could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Estée Lauder Companies' to be considered reasonable.
Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 18% in total. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.
Looking ahead now, EPS is anticipated to climb by 13% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 9.3% each year, which is noticeably less attractive.
With this information, we can see why Estée Lauder Companies 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
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.
As we suspected, our examination of Estée Lauder Companies' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.