Elgi Equipments Limited's (NSE:ELGIEQUIP) Business Is Trailing The Market But Its Shares Aren't

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 29x, you may consider Elgi Equipments Limited (NSE:ELGIEQUIP) as a stock to avoid entirely with its 49.8x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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With earnings growth that's inferior to most other companies of late, Elgi Equipments has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Elgi Equipments

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How Is Elgi Equipments' Growth Trending?

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

Taking a look back first, we see that the company managed to grow earnings per share by a handy 12% last year. This was backed up an excellent period prior to see EPS up by 96% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 16% per year during the coming three years according to the four analysts following the company. With the market predicted to deliver 22% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Elgi Equipments is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Final Word

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.

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. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a 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.