Elecon Engineering Company Limited's (NSE:ELECON) 33% Price Boost Is Out Of Tune With Earnings

Elecon Engineering Company Limited (NSE:ELECON) shares have continued their recent momentum with a 33% gain in the last month alone. The annual gain comes to 133% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Elecon Engineering's price-to-earnings (or "P/E") ratio of 42.2x 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 17x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Elecon Engineering certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See 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?

Elecon Engineering's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered an exceptional 50% gain to the company's bottom line. The latest three year period has also seen an excellent 517% 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 only analyst covering the company suggest earnings should grow by 9.8% 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 Elecon Engineering'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 Key Takeaway

Elecon Engineering's P/E is getting right up there since its shares have risen strongly. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Elecon Engineering currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Elecon Engineering, and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.