With a median price-to-earnings (or "P/E") ratio of close to 28x in India, you could be forgiven for feeling indifferent about Kirloskar Oil Engines Limited's (NSE:KIRLOSENG) P/E ratio of 30.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
While the market has experienced earnings growth lately, Kirloskar Oil Engines' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is moderate because investors think this poor earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.
Check out our latest analysis for Kirloskar Oil Engines
Does Growth Match The P/E?
The only time you'd be comfortable seeing a P/E like Kirloskar Oil Engines' is when the company's growth is tracking the market closely.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 1.9%. Even so, admirably EPS has lifted 108% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 13% per year during the coming three years according to the four analysts following the company. With the market predicted to deliver 19% growth per year, the company is positioned for a weaker earnings result.
In light of this, it's curious that Kirloskar Oil Engines' P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Final Word
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.
Our examination of Kirloskar Oil Engines' analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Having said that, be aware Kirloskar Oil Engines is showing 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant.
If you're unsure about the strength of Kirloskar Oil Engines' 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.