The Market Lifts Canadian Solar Inc. (NASDAQ:CSIQ) Shares 26% But It Can Do More

Canadian Solar Inc. (NASDAQ:CSIQ) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. But the last month did very little to improve the 56% share price decline over the last year.

In spite of the firm bounce in price, Canadian Solar's price-to-earnings (or "P/E") ratio of 6.2x might still make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 32x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With earnings that are retreating more than the market's of late, Canadian Solar has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

Check out our latest analysis for Canadian Solar

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How Is Canadian Solar's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as depressed as Canadian Solar's is when the company's growth is on track to lag the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 37%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 211% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 34% per annum as estimated by the nine analysts watching the company. That's shaping up to be materially higher than the 10.0% per year growth forecast for the broader market.

In light of this, it's peculiar that Canadian Solar's P/E sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Bottom Line On Canadian Solar's P/E

Canadian Solar's recent share price jump still sees its P/E sitting firmly flat on the ground. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Canadian Solar currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

You need to take note of risks, for example - Canadian Solar has 3 warning signs (and 2 which don't sit too well with us) we think you should know about.

If you're unsure about the strength of Canadian Solar'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.