With a price-to-earnings (or "P/E") ratio of 48.5x Contact Energy Limited (NZSE:CEN) may be sending very bearish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios under 15x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times haven't been advantageous for Contact Energy as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Contact Energy's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Contact Energy's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 31% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 7.4% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 31% per year as estimated by the five analysts watching the company. With the market only predicted to deliver 20% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Contact Energy's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Contact Energy's P/E

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.

As we suspected, our examination of Contact Energy's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.