Earnings Not Telling The Story For Elgi Equipments Limited (NSE:ELGIEQUIP) After Shares Rise 30%

Elgi Equipments Limited (NSE:ELGIEQUIP) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 36% in the last year.

After such a large jump in price, Elgi Equipments' price-to-earnings (or "P/E") ratio of 74.6x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 33x and even P/E's below 19x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Elgi Equipments could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Is There Enough Growth For Elgi Equipments?

In order to justify its P/E ratio, Elgi Equipments would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 204% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Looking ahead now, EPS is anticipated to climb by 17% each year during the coming three years according to the six analysts following the company. Meanwhile, the rest of the market is forecast to expand by 22% per year, which is noticeably more attractive.

With this information, we find it concerning that Elgi Equipments 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. 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.

What We Can Learn From Elgi Equipments' P/E?

The strong share price surge has got Elgi Equipments' P/E rushing to great heights as well. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Elgi Equipments 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Elgi Equipments with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Elgi Equipments, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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