There Is A Reason Neoenergia S.A.'s (BVMF:NEOE3) Price Is Undemanding

When close to half the companies in Brazil have price-to-earnings ratios (or "P/E's") above 8x, you may consider Neoenergia S.A. (BVMF:NEOE3) as an attractive investment with its 5.9x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Neoenergia hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

See our latest analysis for Neoenergia

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Neoenergia.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Neoenergia's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 15%. This means it has also seen a slide in earnings over the longer-term as EPS is down 12% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 13% during the coming year according to the nine analysts following the company. That's not great when the rest of the market is expected to grow by 16%.

With this information, we are not surprised that Neoenergia is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

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 Neoenergia's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 2 warning signs for Neoenergia (1 is significant!) that we have uncovered.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.