The Wesfarmers Ltd (ASX: WES) share price soared in the last 12 months, rising by more than 20%, as the chart below shows.
The company behind names like Bunnings, Kmart, Officeworks, Priceline and Target has been a successful investment.
A question for investors is whether this is a good valuation to dive into the diversified business and buy new shares. A price/earnings (P/E) ratio can only grow so far before it becomes unsustainable.
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How high is the P/E ratio?
It's important to focus on the upcoming financial year's earnings rather than last year's because investors usually focus on the future rather than the past. Future earnings expectations are probably how the market values the stock.
The broker UBS predicts that Wesfarmers' profit could grow in the low single digits in percentage terms during FY25. Net profit could grow to $2.64 billion in the 2025 financial year, while earnings per share (EPS) could reach $2.32.
Those possible profit numbers put the Wesfarmers share price at 31x FY25's estimated earnings. When retail conditions were booming, and interest rates were very low in FY21 and FY22, the Wesfarmers share price traded at an average annual P/E ratio of 23 and 26, according to Commsec.
On an earnings multiple basis, the company seems highly priced compared to historical values. A future share price decline could send the P/E ratio lower in the future.
Is the Wesfarmers share price a buy?
The famous investor Warren Buffett once said it's better to buy a wonderful business at a fair price than a fair business at a wonderful price.
Bunnings and Kmart are wonderful businesses. They have market-leading positions and can offer customers great value because of their scale and business strategies.
However, the higher the Wesfarmers share price, the more difficult it is to call it a fair price.
I'd rather buy Wesfarmers shares today over most other ASX blue-chip shares like Commonwealth Bank of Australia (ASX: CBA). I like the diversification of Wesfarmers, which also includes an industrial and safety division and a chemicals, energy and fertiliser (WesCEF) segment – the company has a broad scope of where it can invest for returns. For example, it's working on a lithium project.
Even if today's price is relatively expensive, Wesfarmers can steadily 'grow into' the valuation.
I believe Wesfarmers will make substantially more profit in the years ahead and justify a higher market capitalisation than today. However, I think there could be other opportunities to consider before this ASX blue-chip share.
