Over the last few weeks, the Wesfarmers Ltd (ASX: WES) share price has climbed to all-time highs. And in the last six months, it has risen by around 30%, beating the S&P/ASX 200 Index (ASX: XJO)'s returns by around 18%.
So, are Wesfarmers shares now overvalued, or still possibly an ASX bargain buy?
As depicted on the chart above, the Wesfarmers share price has had a top run over the past year. It's also probably one of the ASX 200 shares I've written most about over this period. That's because I liked the company's outlook, its valuation, the underlying businesses, and its financial metrics.
But what do I think now that Wesfarmers is trading at all-time highs? Well, in all honesty, I don't think I can call Wesfarmers shares a bargain at current prices. But let's take a look at some factors that could make investors cautious, and other reasons the stock could still be worth buying right now.
Remain cautious?
Naturally, the rising Wesfarmers share price has also pushed its forward price-to-earnings (P/E) ratio higher. According to Commsec, Wesfarmers shares are now trading at more than 30x FY24's estimated earnings.
The rapid rise in the share price is good for current shareholders, but it may make it trickier for newer investors to make solid returns in the short term. For example, if Wesfarmers shares are trading at $70 in 12 months, then this would only represent a rise of 2.3% from today's price of $68.40. But if the Wesfarmers share price were only $65 right now, it'd be a gain of 7.7%.
So is Wesfarmers' current valuation justified? Interest rates are still high compared to pre-Covid levels – and central bankers don't appear to be in any rush to deliver cuts. Wesfarmers' profit hasn't exactly been soaring either – FY24 first-half net profit after tax (NPAT) only grew by 3%.
Here's what legendary investor Warren Buffett once said about the impact of interest rates on a company's valuation:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature… its intrinsic valuation is 100% sensitive to interest rates.
In other words, investors should take into account high interest rates because they, in theory, reduce the underlying value of assets.
A higher Wesfarmers share price also has an unfortunate effect on the dividend yield for prospective investors – the higher the share price, the lower the dividend yield. According to Commsec estimates, Wesfarmers could pay a grossed-up dividend yield of 4% in FY24. While this is not to be sneezed at, dividend investors may be tempted to go searching for higher yields elsewhere on the ASX 200.
Why I'd still buy Wesfarmers shares
Wesfarmers' profit didn't grow much in the HY24 result and may only slightly improve in FY24. Strong profit growth would help move the stock towards being an ASX bargain buy in my view.
However, we shouldn't just base our valuation thoughts on a 12-month period. Firstly, I think it's impressive that the company is managing to grow its profit at all in the current climate, with many households tightening their belts amid the surging cost of living.
Secondly, it's true that Wesfarmers' earnings per share (EPS) may only reach $2.23 in FY24, but it is projected to grow 21% to $2.70 by FY26. That would put the Wesfarmers share price at 25x FY26's estimated earnings.
So, in my mind, growing profit can justify a higher share price. If company profit keeps rising, then the Wesfarmers share price can theoretically keep climbing.
Furthermore, Kmart and Bunnings are great businesses. They earn strong returns on capital (ROC) and Wesfarmers overall typically achieves a very good return on equity (ROE).
Australia's growing population is also helping increase the total number of potential customers for Wesfarmers.
Foolish takeaway
While the Wesfarmers share price has run hard, and could fall in the shorter term (making it better value), I still think, given the quality of the company, it represents solid long-term buying at current levels.
