Tata Coffee Limited's (NSE:TATACOFFEE) Shares May Have Run Too Fast Too Soon

With a price-to-earnings (or "P/E") ratio of 21.2x Tata Coffee Limited (NSE:TATACOFFEE) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 14x and even P/E's lower than 7x 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.

Tata Coffee certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Is There Enough Growth For Tata Coffee?

Tata Coffee's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 39%. However, this wasn't enough as the latest three year period has seen a very unpleasant 31% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 1.5% during the coming year according to the sole analyst following the company. With the market predicted to deliver 3.5% growth , the company is positioned for a comparable earnings result.

In light of this, it's curious that Tata Coffee's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Final Word

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 Tata Coffee currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Tata Coffee that you should be aware of.

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

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