There's Reason For Concern Over Telefônica Brasil S.A.'s (BVMF:VIVT3) Price

Telefônica Brasil S.A.'s (BVMF:VIVT3) price-to-earnings (or "P/E") ratio of 17.7x might make it look like a strong sell right now compared to the market in Brazil, where around half of the companies have P/E ratios below 9x and even P/E's below 6x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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With earnings growth that's superior to most other companies of late, Telefônica Brasil has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Telefônica Brasil

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Telefônica Brasil's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a worthy increase of 14%. However, this wasn't enough as the latest three year period has seen an unpleasant 2.2% overall drop in EPS. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 20% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 19% per annum, which is not materially different.

In light of this, it's curious that Telefônica Brasil's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Telefônica Brasil's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Telefônica Brasil currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Telefônica Brasil that you should be aware of.

If you're unsure about the strength of Telefônica Brasil's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.