If you own shares of Wesfarmers Ltd (ASX: WES), congratulations!
Over the past year, the Wesfarmers share price has surged 32% to reach $65.18, outperforming the S&P/ASX 200 Index (ASX: XJO), which has grown 8% in the same period.
This remarkable performance can be attributed to the strength of Wesfarmers' renowned retail brands, such as Bunnings, Kmart, and Officeworks. After all, who doesn't enjoy visiting these stores on the weekends?
Beyond retail, Wesfarmers also maintains diverse business interests spanning chemicals, industrials, and healthcare providers.
Given its strong portfolio and recent performance, the question remains: Can Wesfarmers shares continue to deliver superior returns going forward?
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What drives share price performance?
The share price of a company can be understood by looking at two key factors: earnings per share (EPS) and the price-to-earnings (PE) ratio.
EPS measures a company's profit divided by the number of shares it has. The PE multiple shows how much investors are willing to pay for each dollar of earnings. By multiplying the EPS by the PE multiple, we get the share price.
For example, Wesfarmers' FY25 EPS estimate of $2.48 and a PE multiple of 26 lead to its share price of $65.18, based on S&P Capital IQ. If the EPS rises to $3, the share price will increase to $78, assuming the PE multiple stays the same.
Thus, share prices change based on both the company's earnings and investor sentiment.
Earnings growth expectations
Wesfarmers' EPS estimates over the next three years appear to assume the company will soon resume a double-digit profit growth. Using S&P Capital IQ estimates, EPS estimates for Wesfarmers are:
- $2.25 in FY24, implying a 3.4% growth over the previous year
- $2.48 in FY25, implying a 10.3% growth over the previous year
- $2.76 in FY26, implying a 11% growth over the previous year
As we reviewed previously, Wesfarmers' business results this year have been mixed. The company's strong retail businesses continue to perform well, but hopes for its upcoming lithium mining venture have lost shine due to weak global commodity prices.
Looking ahead, the company remains confident about its retail business and, as my colleague Tristan highlighted, it expects lithium hydroxide production to commence in the first half of the 2025 calendar year.
PE multiples are high
Wesfarmers shares are currently trading at 26x FY25 earnings estimates. Historically, their PE multiples have ranged from 15x to 32x, making the current valuation relatively high.
Comparing Wesfarmers to its peers, based on earnings estimates provided by S&P Capital IQ:
- Woolworths Group Ltd (ASX: WOW) shares are valued at 23x FY25's estimated earnings.
- Coles Group Ltd (ASX: COL) shares are valued at 20x FY25's estimated earnings.
Given this context, it seems unlikely that Wesfarmers' PE multiple will increase significantly from its current level.
Can Wesfarmers shares outperform the ASX 200?
Over the last 10 years, the ASX 200 Index generated a total return of 7.6%, including a dividend yield of 4.7%.
As discussed, Wesfarmers shares have the potential to outperform the index if the company achieves the expected 10% EPS growth while maintaining a 26x PE multiple. However, the success of this largely depends on the progress of its lithium projects and the direction of global commodity prices in particular.
Despite this uncertainty, Wesfarmers remains one of the top dividend payers on the ASX, currently offering a fully franked dividend yield of 3%. While it's challenging to predict when lithium prices will rise, Wesfarmers shares can be a valuable addition for dividend-focused investors.
