There's Reason For Concern Over Emerald Tyre Manufacturers Limited's (NSE:ETML) Massive 25% Price Jump

Despite an already strong run, Emerald Tyre Manufacturers Limited (NSE:ETML) shares have been powering on, with a gain of 25% in the last thirty days. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

In spite of the firm bounce in price, there still wouldn't be many who think Emerald Tyre Manufacturers' price-to-earnings (or "P/E") ratio of 27.3x is worth a mention when the median P/E in India is similar at about 29x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

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As an illustration, earnings have deteriorated at Emerald Tyre Manufacturers over the last year, which is not ideal at all. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Check out our latest analysis for Emerald Tyre Manufacturers

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Emerald Tyre Manufacturers' earnings, revenue and cash flow.

How Is Emerald Tyre Manufacturers' Growth Trending?

There's an inherent assumption that a company should be matching the market for P/E ratios like Emerald Tyre Manufacturers' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 25%. Still, the latest three year period has seen an excellent 41% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it interesting that Emerald Tyre Manufacturers is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From Emerald Tyre Manufacturers' P/E?

Emerald Tyre Manufacturers appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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.

Our examination of Emerald Tyre Manufacturers revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Emerald Tyre Manufacturers (2 shouldn't be ignored!) that you should be aware of before investing here.

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

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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.