Voltas Limited's (NSE:VOLTAS) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 29x, you may consider Voltas Limited (NSE:VOLTAS) as a stock to avoid entirely with its 52.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Voltas certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Voltas

Keen to find out how analysts think Voltas' future stacks up against the industry? In that case, our free report is a great place to start.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 234%. The strong recent performance means it was also able to grow EPS by 67% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 18% each year as estimated by the analysts watching the company. With the market predicted to deliver 22% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Voltas is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

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.

Our examination of Voltas' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near 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 high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Voltas (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.

You might be able to find a better investment than Voltas. 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.