Pinning Down Elgi Equipments Limited's (NSE:ELGIEQUIP) P/E Is Difficult Right Now

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 33x, you may consider Elgi Equipments Limited (NSE:ELGIEQUIP) as a stock to avoid entirely with its 60.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Elgi Equipments hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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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Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 15%. Still, the latest three year period has seen an excellent 163% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 17% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 19% per annum, which is noticeably more attractive.

In light of this, it's alarming that Elgi Equipments' P/E sits above the majority of other companies. 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. 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.

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

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.

Our examination of Elgi Equipments' 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. 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 you're unsure about the strength of Elgi Equipments' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.