Risks Still Elevated At These Prices As Honda India Power Products Limited (NSE:HONDAPOWER) Shares Dive 25%

Honda India Power Products Limited (NSE:HONDAPOWER) shareholders won't be pleased to see that the share price has had a very rough month, dropping 25% and undoing the prior period's positive performance. Longer-term, the stock has been solid despite a difficult 30 days, gaining 20% in the last year.

Even after such a large drop in price, Honda India Power Products' price-to-earnings (or "P/E") ratio of 44.9x might still make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 31x and even P/E's below 18x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

As an illustration, earnings have deteriorated at Honda India Power Products over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Honda India Power Products

Although there are no analyst estimates available for Honda India Power Products, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Honda India Power Products' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 4.3% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 27% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Honda India Power Products' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Honda India Power Products' P/E hasn't come down all the way after its stock plunged. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Honda India Power Products revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Honda India Power Products that you need to be mindful of.

Of course, you might also be able to find a better stock than Honda India Power Products. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.