Mediocre performance ensures a low price-to-earnings ratio of Rio Paranapanema Energia SA (BVMF:GEPA3)

When almost half of Brazil’s companies have a price-to-earnings ratio (or ‘P/E’) above 11x, you might consider Rio Paranapanema Energia SA (BVMF:GEPA3) as an attractive investment with a price/earnings ratio of 6.9x. Although it is not wise to take the price-to-earnings ratio at face value as there may be an explanation as to why it is limited.

Recent times have been very good for Rio Paranapanema Energia, as profits have increased very quickly. It may be that many expect the strong earnings figures to deteriorate materially, which has weighed on the price/earnings ratio. If you like the company, you hope you don’t, so you can potentially pick up some shares while it’s out of favor.

Check out our latest analysis for Rio Paranapanema Energia

We don’t have analyst forecasts, but you can see how recent trends are positioning the company for the future by checking out our free report on Rio Paranapanema Energia’s earnings, revenue and cash flow.

Does the growth correspond to the low price-earnings ratio?

There is an inherent assumption that a company must underperform the market for price-to-earnings ratios like Rio Paranapanema Energia’s to be considered reasonable.

With retroactive effect, the past year delivered an exceptional gain of 40% for the operating result. Despite this strong recent growth, it is still struggling to catch up, as three-year profits frustratingly shrank by a total of 51%. Therefore, it’s fair to say that earnings growth has been undesirable for the company lately.

Comparing that medium-term earnings trajectory against the broader market’s one-year forecast for 21% growth reveals an unpleasant picture.

With this information, we’re not surprised that Rio Paranapanema Energia is trading at a price-to-earnings ratio below the market. However, we think shrinking profits are unlikely to lead to a stable price-earnings ratio in the longer term, which could cause future disappointment for shareholders. There is a possibility that the price-to-earnings ratio could fall to an even lower level if the company does not improve its profitability.

The result of the price-earnings ratio of Rio Paranapanema Energia

It is argued that the price-to-earnings ratio is an inferior measure of value within certain sectors, but that it can be a powerful indicator of business confidence.

As we suspected, our research of Rio Paranapanema Energia found that shrinking earnings are contributing to the low price-to-earnings ratio in the medium term as the market is expected to grow. At this point, shareholders accept the low price/earnings because they admit that future earnings are unlikely to bring any pleasant surprises. If recent medium-term earnings trends continue, it’s hard to see the share price moving significantly in either direction in the near future under these conditions.

It is also worth noting that we have found 3 Warning Signs for Rio Paranapanema Energia (2 doesn’t sit well with us!) that you should take into account.

Naturally, you may also be able to find a better stock than Rio Paranapanema Energia. So you might want to see this free collection of other companies that have reasonable price-to-earnings ratios and have grown profits strongly.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. We aim to provide you with targeted, long-term analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Simply Wall St has no positions in the stocks mentioned.