Force Motors Limited's (NSE:FORCEMOT) Share Price Not Quite Adding Up

With a price-to-earnings (or "P/E") ratio of 24.5x Force Motors Limited (NSE:FORCEMOT) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 12x and even P/E's lower than 6x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For example, consider that Force Motors' financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Force Motors

Where Does Force Motors' P/E Sit Within Its Industry?

We'd like to see if P/E's within Force Motors' industry might provide some colour around the company's particularly high P/E ratio. It turns out the Machinery industry in general has a P/E ratio similar to the market, as the graphic below shows. So unfortunately this doesn't provide a lot to explain the company's ratio right now. In the context of the Machinery industry's current setting, most of its constituents' P/E's would be expected to be held back. We'd highlight though, the spotlight should be on the anticipated direction of the company's earnings.

Although there are no analyst estimates available for Force Motors, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Force Motors would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 65% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 72% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

This is in contrast to the rest of the market, which is expected to decline by 4.8% over the next year, or less than the company's recent medium-term annualised earnings decline.

With this information, it's strange that Force Motors is trading at a higher P/E in comparison. With earnings going quickly in reverse, it's not guaranteed that the P/E has found a floor yet. There's potential for the P/E to fall to lower levels if the company doesn't improve its profitability, which would be difficult to do with the current market outlook.

What We Can Learn From Force Motors' P/E?

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 Force Motors currently trades on a much higher than expected P/E since its recent three-year earnings are even worse than the forecasts for a struggling market. When we see below average earnings, we suspect the share price is at risk of declining, sending the high P/E lower. In addition, we would be concerned whether the company can even maintain its medium-term level of performance under these tough market conditions. This would place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Force Motors (at least 1 which is a bit concerning), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Force Motors, explore our interactive list of high quality stocks to get an idea of what else is out there.

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