What Tarmat Limited's (NSE:TARMAT) 27% Share Price Gain Is Not Telling You

Despite an already strong run, Tarmat Limited (NSE:TARMAT) shares have been powering on, with a gain of 27% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 99% in the last year.

After such a large jump in price, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 31x, you may consider Tarmat as a stock to potentially avoid with its 38.4x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

The earnings growth achieved at Tarmat over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Tarmat

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Tarmat's earnings, revenue and cash flow.

How Is Tarmat's Growth Trending?

In order to justify its P/E ratio, Tarmat would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 18%. However, this wasn't enough as the latest three year period has seen a very unpleasant 50% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 25% shows it's an unpleasant look.

In light of this, it's alarming that Tarmat's P/E sits above the majority of other companies. 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Tarmat's P/E?

Tarmat's P/E is getting right up there since its shares have risen strongly. 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 Tarmat 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 3 warning signs for Tarmat that you need to be mindful of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.