Action Construction Equipment Limited's (NSE:ACE) Shares Climb 27% But Its Business Is Yet to Catch Up

Despite an already strong run, Action Construction Equipment Limited (NSE:ACE) shares have been powering on, with a gain of 27% in the last thirty days. The last month tops off a massive increase of 199% in the last year.

After such a large jump in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 32x, you may consider Action Construction Equipment as a stock to avoid entirely with its 49.2x 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.

With earnings growth that's superior to most other companies of late, Action Construction Equipment has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Action Construction Equipment

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Action Construction Equipment.

How Is Action Construction Equipment's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Action Construction Equipment's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 74%. The latest three year period has also seen an excellent 388% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 7.8% over the next year. With the market predicted to deliver 25% growth , the company is positioned for a weaker earnings result.

In light of this, it's alarming that Action Construction Equipment's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Action Construction Equipment's P/E

Shares in Action Construction Equipment have built up some good momentum lately, which has really inflated its P/E. 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 Action Construction Equipment's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Action Construction Equipment with six simple checks on some of these key factors.

You might be able to find a better investment than Action Construction Equipment. 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.