The forward price-to-earnings (P/E) ratio — share price divided by the consensus of analysts’ forecasts for earnings per share (EPS) — is probably the single most popular valuation measure used by investors.
However, it can pay to look beyond the consensus to the spread between the most bullish and bearish EPS forecasts. The table below shows the effect of different spreads on a company with a consensus P/E of 14 (the long-term FTSE 100 average).
| EPS spread | Bull extreme P/E | Consensus P/E | Bear extreme P/E |
|---|---|---|---|
| Narrow 10% (+ and – 5%) | 13.3 | 14.0 | 14.7 |
| Average 40% (+ and – 20%) | 11.7 | 14.0 | 17.5 |
| Wide 100% (+ and – 50%) | 9.3 | 14.0 | 28.0 |
In the case of the narrow spread, you probably wouldn’t be too unhappy if the bear analyst’s EPS forecast panned out, and you found you’d bought on a P/E of 14.7, rather than the consensus 14. But how about if the bear analyst was on the button in the case of the wide spread? Not so happy, I’d imagine!
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Wm. Morrison Supermarkets
Today, I’m analysing the UK’s number four supermarket group Wm. Morrison Supermarkets (LSE: MRW). The data for the company’s financial year ending February 2015 is summarised in the table below.
| Share price 196p | Forecast EPS | +/- consensus | P/E |
|---|---|---|---|
| Consensus | 13.7p | n/a | 14.3 |
| Bull extreme | 26.5p | +93% | 7.4 |
| Bear extreme | 6.8p | -50% | 28.8 |
As you can see, with the most bullish EPS forecast 93% higher than the consensus, and the most bearish 50% lower, the 143% spread massively exceeds the 40% spread of the average blue-chip company. The range gapes wider still against the narrower-than-average spreads of supermarket rivals J Sainsbury (37%) and Tesco (33%).
Playing catch-up with its Footsie rivals in the supermarket growth areas of internet shopping and convenience stores, and especially vulnerable to having its customers poached by the flourishing hard discounters Aldi and Lidl, Morrisons is in trouble.
Annual results released in March showed sales down 2% and underlying profit before tax down 13% to £785m. Worse still, in announcing a strategy of price cuts to fight back against the discounters, Morrisons said underlying profits in 2014/15 will be down to between £325m and £375m.
Now, given the guidance, and given last year’s underlying EPS of 25.2p, I can’t for the life of me see how the bull EPS forecast of 26.5p in the table above can be credible. It suggests to me that the consensus P/E of 14.3, which is already a tad above the FTSE 100 long-term average of 14, should be even higher. Meanwhile, the bear extreme P/E of 28.8 seems perfectly plausible, given the challenges Morrisons is facing.
The troubled supermarket is unlocking £1bn from its property portfolio to help it through the next three years, but, unless you believe that the dividend management has promised for the year ahead (a whopping 7% yield at the current share price) will be delivered, and is sustainable, the company doesn’t look to hold a great deal of appeal. Certainly not on a P/E basis.
