There's No Escaping Energy Action Limited's (ASX:EAX) Muted Earnings Despite A 29% Share Price Rise

Energy Action Limited (ASX:EAX) shares have had a really impressive month, gaining 29% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 45%.

In spite of the firm bounce in price, Energy Action's price-to-earnings (or "P/E") ratio of 8.8x might still make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 21x and even P/E's above 39x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

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Energy Action certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

See our latest analysis for Energy Action

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Energy Action's earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Energy Action would need to produce anemic growth that's substantially trailing the market.

Retrospectively, the last year delivered an exceptional 174% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 23% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we can see why Energy Action is trading at a P/E lower than the market. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

What We Can Learn From Energy Action's P/E?

Shares in Energy Action are going to need a lot more upward momentum to get the company's P/E out of its slump. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Energy Action revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Energy Action is showing 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

Of course, you might also be able to find a better stock than Energy Action. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.