There's Reason For Concern Over Kitex Garments Limited's (NSE:KITEX) Massive 31% Price Jump

Despite an already strong run, Kitex Garments Limited (NSE:KITEX) shares have been powering on, with a gain of 31% in the last thirty days. The last month tops off a massive increase of 205% in the last year.

Following the firm bounce in price, Kitex Garments' price-to-earnings (or "P/E") ratio of 42.4x might make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 30x and even P/E's below 18x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings growth that's exceedingly strong of late, Kitex Garments 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.

See our latest analysis for Kitex Garments

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 Kitex Garments' earnings, revenue and cash flow.

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

Kitex Garments' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 193% last year. Pleasingly, EPS has also lifted 43% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 26% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Kitex Garments 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

Kitex Garments' P/E is getting right up there since its shares have risen strongly. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Kitex Garments revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Kitex Garments (2 are concerning!) that you need to be mindful of.

Of course, you might also be able to find a better stock than Kitex Garments. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.