Insufficient Growth At Colbún S.A. (SNSE:COLBUN) Hampers Share Price

Colbún S.A.'s (SNSE:COLBUN) price-to-earnings (or "P/E") ratio of 5.8x might make it look like a buy right now compared to the market in Chile, where around half of the companies have P/E ratios above 9x and even P/E's above 14x 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 limited.

Recent times have been pleasing for Colbún as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Colbún

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Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 318% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 159% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 27% during the coming year according to the five analysts following the company. That's not great when the rest of the market is expected to grow by 23%.

In light of this, it's understandable that Colbún's P/E would sit below the majority of other companies. 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 Bottom Line On Colbún's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Colbún's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 3 warning signs for Colbún you should be aware of, and 1 of them can't be ignored.

If these risks are making you reconsider your opinion on Colbún, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.