With a price-earnings ratio (P/E) of 27.8 The Coca-Cola Company (NYSE:KO) may be sending very bearish signals right now, as nearly half of all companies in the U.S. have a P/E ratio below 17x, and even P/E ratios below 10x are not uncommon. However, the P/E ratio might be quite high for a reason, and further research is needed to determine if it is justified.

With earnings growth in positive territory compared to the declining earnings of most other companies, Coca-Cola has done quite well recently. It seems that many expect the company to continue to defy general market adversities, which has increased investors’ willingness to pay more for the stock. If not, existing shareholders may be a little nervous about the sustainability of the share price.

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How is Coca-Cola growing?

To justify its P/E ratio, Coca-Cola would have to achieve outstanding growth that significantly outperformed the market.

Looking back, last year saw the company generate virtually the same profit as the year before. However, a few strong years prior to that meant the company was able to grow earnings per share by an impressive 32% over the last three years. Accordingly, shareholders would likely have welcomed these medium-term earnings growth rates.

Looking ahead, analysts who cover the company expect earnings to grow 9.8% per year over the next three years, roughly in line with the 10% per year growth forecast for the overall market.

Given this information, we find it interesting that Coca-Cola is trading at a high P/E relative to the market. It appears that many investors in the company are more optimistic than analysts indicate and are not willing to sell their shares at this time. These shareholders may have to prepare for disappointment if the P/E falls to a level more in line with the growth prospects.

The conclusion on the P/E ratio of Coca-Cola

It’s not a good idea to use the price-to-earnings ratio alone to decide whether to sell your stock, but it can be a useful guide to the company’s future prospects.

Our study of analyst forecasts for Coca-Cola found that the market earnings outlook does not influence the high P/E as much as we would have expected. When we see an average earnings outlook with market growth, we suspect the share price could decline, driving the high P/E down. This puts shareholders’ investments at risk and potential investors risk paying an unnecessary premium.

Before you form an opinion, we found out 3 warning signs for Coca-Cola that you should know.

If this Risks make you rethink your opinion of Coca-Colaexplore our interactive list of high-quality stocks to get a sense of what else is out there.

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