When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 29x, you may consider L&T Technology Services Limited (NSE:LTTS) as a stock to potentially avoid with its 36.8x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
L&T Technology Services hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for L&T Technology Services
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like L&T Technology Services' to be considered reasonable.
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 3.0%. Even so, admirably EPS has lifted 31% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 14% per year over the next three years. With the market predicted to deliver 22% growth per year, the company is positioned for a weaker earnings result.
In light of this, it's alarming that L&T Technology Services' P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
What We Can Learn From L&T Technology Services' P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that L&T Technology Services currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. 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 1 warning sign with L&T Technology Services, and understanding should be part of your investment process.
If you're unsure about the strength of L&T Technology Services' 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.