Investor Optimism Abounds Rio Paranapanema Energia S.A. (BVMF:GEPA3) But Growth Is Lacking

Rio Paranapanema Energia S.A.'s (BVMF:GEPA3) price-to-earnings (or "P/E") ratio of 11.2x might make it look like a sell right now compared to the market in Brazil, where around half of the companies have P/E ratios below 8x 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 elevated P/E.

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For instance, Rio Paranapanema Energia's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Rio Paranapanema Energia

Although there are no analyst estimates available for Rio Paranapanema Energia, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The High P/E?

Rio Paranapanema Energia's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 21% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 44% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 11% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Rio Paranapanema Energia is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

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 Rio Paranapanema Energia currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Rio Paranapanema Energia is showing 3 warning signs in our investment analysis, and 2 of those are a bit concerning.

If you're unsure about the strength of Rio Paranapanema Energia'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.