Capital Power Corporation's (TSE:CPX) 29% Price Boost Is Out Of Tune With Earnings

Capital Power Corporation (TSE:CPX) shareholders have had their patience rewarded with a 29% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 45% in the last year.

Following the firm bounce in price, Capital Power's price-to-earnings (or "P/E") ratio of 27.7x might make it look like a strong sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 16x and even P/E's below 10x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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Capital Power could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Capital Power

Want the full picture on analyst estimates for the company? Then our free report on Capital Power will help you uncover what's on the horizon.

Is There Enough Growth For Capital Power?

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

Retrospectively, the last year delivered a frustrating 41% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 135% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 9.0% per year during the coming three years according to the six analysts following the company. With the market predicted to deliver 12% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Capital Power is trading at a P/E higher than the market. 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 Key Takeaway

Shares in Capital Power have built up some good momentum lately, which has really inflated its P/E. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Capital Power currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Capital Power is showing 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant.

If you're unsure about the strength of Capital Power'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.