Contact Energy Limited's (NZSE:CEN) Popularity With Investors Is Under Threat From Overpricing

With a price-to-earnings (or "P/E") ratio of 27.6x Contact Energy Limited (NZSE:CEN) may be sending bearish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been pleasing for Contact Energy as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Contact Energy

Keen to find out how analysts think Contact Energy's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Contact Energy's Growth Trending?

Contact Energy's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered an exceptional 84% gain to the company's bottom line. The latest three year period has also seen a 18% overall rise in EPS, aided extensively by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Turning to the outlook, the next three years should generate growth of 7.7% per annum as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 18% per year, which is noticeably more attractive.

With this information, we find it concerning that Contact Energy is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Contact Energy's 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 Contact Energy 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Contact Energy has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on Contact Energy, 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.