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Why the Wesfarmers share price is too expensive

Is the Wesfarmers Ltd (ASX: WES) share price too expensive?

Wesfarmers is one of the largest and most popular companies on the ASX for Aussie investors. The company has a massive presence in the Australian retail scene, after all. It owns the stupendously successful hardware chain Bunnings, as well as the Officeworks, Kmart and Target store chains.

It also used to own Coles Group Ltd (ASX: COL) before Coles was kicked out of the Wesfarmers nest and spun off to live life on its own terms in late 2018. Before Coles was demerged, Wesfarmers was actually the largest non-public employer in the country. The company still retains a 5% stake in Coles to this day.

In addition to the retail stores listed above, Wesfarmers also owns a significant portfolio of other businesses. It owns the Kleenheat brand of gas, Covalent Lithium and the WorkWear clothing brand, amongst many others. If you’re looking for a diversified conglomerate, then this is Australia’s largest by far.

It’s a bold claim then, perhaps, to label Wesfarmers as overvalued. But I think there is sufficient cause here.

Is the Wesfarmers share price overvalued?

So on current pricing, Wesfarmers is asking a price of $47.01 a share. That gives the stock a price-to-earnings (P/E) ratio of 24.38 and a trailing dividend yield of 3.25% (which comes fully franked).

By comparison, the broader S&P/ASX 200 Index (ASX: XJO) currently has an average P/E ratio of 16.99. So the market is pricing Wesfarmers far above the market average, for a start.

But let’s look at some of Wesfarmers’ numbers.

In the 6 months to 31 December 2019, Wesfarmers reported 6% growth in revenue and 4.4% growth in after-tax profits. solid numbers to be sure, but nothing exciting in my opinion. Ditto with Wesfarmers’ dividends. A 3.25% yield is solid, but nothing to write home about.

Not only that, but last year’s interim dividend came in at $1 per share. In February this year, Wesfarmers only delivered a 75 cents per share dividend (a 25% drop). This does take into account the demerger of Coles (from which Wesfarmers shareholders received an additional special dividend), but it still doesn’t excite me.

So for a company with (pre-coronavirus) revenue growth of 6% and a dividend yield of 3.25%, we are being asked to pay 24.38x earnings. It’s a ‘no deal’ for me.

Foolish takeaway

Wesfarmers is due to report its full-year earnings on 20 August, so it will be interesting to see what the past 12 months have thrown up for the company. Even so, there is nothing in the current Wesfarmers share price that leads me to believe the shares are anything but too expensive.

Yes, it’s a relatively stable and diversified company. But it is also one that is not growing very fast, and which I think there are few growth avenues left to meaningfully pursue. As such, I think there are better options out there for growth and income investors alike than Wesfarmers shares today.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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