Subdued Growth No Barrier To Sterling Tools Limited (NSE:STERTOOLS) With Shares Advancing 35%

Sterling Tools Limited (NSE:STERTOOLS) shares have had a really impressive month, gaining 35% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 92% in the last year.

After such a large jump in price, Sterling Tools' price-to-earnings (or "P/E") ratio of 36.9x might make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 31x and even P/E's below 18x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been quite advantageous for Sterling Tools as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Sterling Tools

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

How Is Sterling Tools' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Sterling Tools' is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 39% last year. The strong recent performance means it was also able to grow EPS by 86% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Sterling Tools 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

The large bounce in Sterling Tools' shares has lifted the company's P/E to a fairly high level. 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 Sterling Tools currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.

Plus, you should also learn about these 2 warning signs we've spotted with Sterling Tools.

You might be able to find a better investment than Sterling Tools. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.