Southern Energy Corp.'s (CVE:SOU) 38% Price Boost Is Out Of Tune With Earnings

Southern Energy Corp. (CVE:SOU) shareholders are no doubt pleased to see that the share price has bounced 38% in the last month, although it is still struggling to make up recently lost ground. The last month tops off a massive increase of 211% in the last year.

Following the firm bounce in price, Southern Energy's price-to-earnings (or "P/E") ratio of 13.5x might make it look like a sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 10x and even P/E's below 4x 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.

For example, consider that Southern Energy's financial performance has been poor lately as it's earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Southern Energy

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 Southern Energy's earnings, revenue and cash flow.

How Is Southern Energy's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 10% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 14% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Southern Energy is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Southern Energy's P/E is getting right up there since its shares have risen strongly. 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 Southern Energy currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.

It is also worth noting that we have found 3 warning signs for Southern Energy (2 shouldn't be ignored!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Southern Energy. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.