With a price-to-earnings (or "P/E") ratio of 5.5x Centrica plc (LON:CNA) may be sending very bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 16x and even P/E's higher than 30x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Centrica 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 you still 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.
View our latest analysis for Centrica
What Are Growth Metrics Telling Us About The Low P/E?
Centrica's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.
Retrospectively, the last year delivered a frustrating 64% decrease to the company's bottom line. Even so, admirably EPS has lifted 178% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings growth is heading into negative territory, declining 15% per year over the next three years. Meanwhile, the broader market is forecast to expand by 15% per year, which paints a poor picture.
With this information, we are not surprised that Centrica 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
What We Can Learn From Centrica's P/E?
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Centrica maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. 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.
It is also worth noting that we have found 4 warning signs for Centrica (2 are significant!) that you need to take into consideration.
You might be able to find a better investment than Centrica. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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