What Elgi Equipments Limited's (NSE:ELGIEQUIP) 27% Share Price Gain Is Not Telling You

The Elgi Equipments Limited (NSE:ELGIEQUIP) share price has done very well over the last month, posting an excellent gain of 27%. The last 30 days bring the annual gain to a very sharp 55%.

After such a large jump in price, Elgi Equipments may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 53.6x, since almost half of all companies in India have P/E ratios under 32x and even P/E's lower than 18x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Recent times have been advantageous for Elgi Equipments as its earnings have been rising faster 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.

Check out our latest analysis for Elgi Equipments

Keen to find out how analysts think Elgi Equipments' future stacks up against the industry? In that case, our free report is a great place to start.

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.

Retrospectively, the last year delivered an exceptional 71% gain to the company's bottom line. Pleasingly, EPS has also lifted 947% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 3.8% per annum as estimated by the four analysts watching the company. With the market predicted to deliver 20% 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. 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.

The Final Word

Elgi Equipments' P/E is flying high just like its stock has during the last month. 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 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Elgi Equipments has 1 warning sign we think you should be aware of.

You might be able to find a better investment than Elgi Equipments. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.