SML Mahindra Limited's (NSE:SMLMAH) 29% Price Boost Is Out Of Tune With Earnings

SML Mahindra Limited (NSE:SMLMAH) shares have had a really impressive month, gaining 29% after a shaky period beforehand. The annual gain comes to 146% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 25x, you may consider SML Mahindra as a stock to avoid entirely with its 39.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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SML Mahindra has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for SML Mahindra

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

How Is SML Mahindra's Growth Trending?

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

Taking a look back first, we see that the company managed to grow earnings per share by a handy 15% last year. Although, the latest three year period in total hasn't been as good as it didn't manage to provide any growth at all. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Comparing that to the market, which is predicted to deliver 25% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that SML Mahindra is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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

The strong share price surge has got SML Mahindra's P/E rushing to great heights as well. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that SML Mahindra currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.

Before you settle on your opinion, we've discovered 2 warning signs for SML Mahindra that you should be aware of.

You might be able to find a better investment than SML Mahindra. 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).

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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.