What Rico Auto Industries Limited's (NSE:RICOAUTO) 31% Share Price Gain Is Not Telling You

Despite an already strong run, Rico Auto Industries Limited (NSE:RICOAUTO) shares have been powering on, with a gain of 31% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 19% over that time.

Following the firm bounce in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 27x, you may consider Rico Auto Industries as a stock to avoid entirely with its 41.5x P/E ratio. 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.

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As an illustration, earnings have deteriorated at Rico Auto Industries over the last year, which is not ideal at all. 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.

View our latest analysis for Rico Auto Industries

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 Rico Auto Industries' earnings, revenue and cash flow.

How Is Rico Auto Industries' Growth Trending?

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

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 4.9% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 25% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Rico Auto Industries is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Rico Auto Industries' P/E is flying high just like its stock has during the last month. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Rico Auto Industries currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Rico Auto Industries (1 doesn't sit too well with us!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than Rico Auto Industries. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.