Market Participants Recognise Axita Cotton Limited's (NSE:AXITA) Earnings Pushing Shares 40% Higher

Axita Cotton Limited (NSE:AXITA) shareholders would be excited to see that the share price has had a great month, posting a 40% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 21x, you may consider Axita Cotton as a stock to avoid entirely with its 34.5x 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.

With earnings growth that's exceedingly strong of late, Axita Cotton has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Axita Cotton

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Is There Enough Growth For Axita Cotton?

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

Retrospectively, the last year delivered an exceptional 290% gain to the company's bottom line. Pleasingly, EPS has also lifted 2,455% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

This is in contrast to the rest of the market, which is expected to grow by 21% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Axita Cotton's P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Bottom Line On Axita Cotton's P/E

Axita Cotton's P/E is flying high just like its stock has during the last month. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Axita Cotton revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Axita Cotton (2 are potentially serious!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Axita Cotton, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.