Kothari Products Limited's (NSE:KOTHARIPRO) Price Is Right But Growth Is Lacking

With a price-to-earnings (or "P/E") ratio of 5.2x Kothari Products Limited (NSE:KOTHARIPRO) may be sending very bullish signals at the moment, given that almost half of all companies in India have P/E ratios greater than 14x and even P/E's higher than 33x are not unusual. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Kothari Products over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

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

In order to justify its P/E ratio, Kothari Products would need to produce anemic growth that's substantially trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 72%. As a result, earnings from three years ago have also fallen 54% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 1.3% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's understandable that Kothari Products' P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

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.

As we suspected, our examination of Kothari Products revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Before you take the next step, you should know about the 6 warning signs for Kothari Products (2 are a bit unpleasant!) that we have uncovered.

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