Elecon Engineering Company Limited's (NSE:ELECON) 31% Price Boost Is Out Of Tune With Earnings

Elecon Engineering Company Limited (NSE:ELECON) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. The last month tops off a massive increase of 162% in the last year.

Since its price has surged higher, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 30x, you may consider Elecon Engineering as a stock to potentially avoid with its 36.8x 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 as high as it is.

Recent times have been advantageous for Elecon Engineering as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Elecon Engineering

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

Does Growth Match The High P/E?

In order to justify its P/E ratio, Elecon Engineering would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 50% last year. Pleasingly, EPS has also lifted 517% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings should grow by 9.8% over the next year. That's shaping up to be materially lower than the 24% growth forecast for the broader market.

With this information, we find it concerning that Elecon Engineering is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

The large bounce in Elecon Engineering's shares has lifted the company's P/E to a fairly high level. 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 Elecon Engineering'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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Elecon Engineering has 1 warning sign we think you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.