Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) Price Is Out Of Tune With Earnings

With a price-to-earnings (or "P/E") ratio of 13.4x Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) may be sending bearish signals at the moment, given that almost half of all companies in Brazil have P/E ratios under 9x and even P/E's lower than 6x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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While the market has experienced earnings growth lately, Companhia de Saneamento Básico do Estado de São Paulo - SABESP's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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How Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Companhia de Saneamento Básico do Estado de São Paulo - SABESP's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. Still, the latest three year period has seen an excellent 137% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 2.8% over the next year. Meanwhile, the rest of the market is forecast to expand by 22%, which is noticeably more attractive.

In light of this, it's alarming that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Companhia de Saneamento Básico do Estado de São Paulo - SABESP currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Companhia de Saneamento Básico do Estado de São Paulo - SABESP that you need to be mindful of.

If you're unsure about the strength of Companhia de Saneamento Básico do Estado de São Paulo - SABESP'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.