Investor Optimism Abounds Elecon Engineering Company Limited (NSE:ELECON) But Growth Is Lacking

With a median price-to-earnings (or "P/E") ratio of close to 33x in India, you could be forgiven for feeling indifferent about Elecon Engineering Company Limited's (NSE:ELECON) P/E ratio of 35.2x. 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.

Elecon Engineering's earnings growth of late has been pretty similar to most other companies. The P/E is probably moderate because investors think this modest earnings performance will continue. If this is the case, then at least existing shareholders won't be losing sleep over the current share price.

Check out our latest analysis for Elecon Engineering

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Does Growth Match The P/E?

In order to justify its P/E ratio, Elecon Engineering would need to produce growth that's similar to the market.

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 200% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings should grow by 12% each year over the next three years. That's shaping up to be materially lower than the 19% per year growth forecast for the broader market.

With this information, we find it interesting that Elecon Engineering 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 Final Word

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 higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for Elecon Engineering you should be aware of.

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.