Some Shareholders Feeling Restless Over Ashok Leyland Limited's (NSE:ASHOKLEY) P/E Ratio

It's not a stretch to say that Ashok Leyland Limited's (NSE:ASHOKLEY) price-to-earnings (or "P/E") ratio of 25.8x right now seems quite "middle-of-the-road" compared to the market in India, where the median P/E ratio is around 28x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

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Ashok Leyland certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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Does Growth Match The P/E?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 31% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 13% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 19% per annum, which is noticeably more attractive.

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

The Key Takeaway

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 Ashok Leyland currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Ashok Leyland (1 is a bit unpleasant!) that you need to be mindful of.

If you're unsure about the strength of Ashok Leyland's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.