Lorenzini Apparels Limited's (NSE:LAL) 81% Share Price Surge Not Quite Adding Up

Lorenzini Apparels Limited (NSE:LAL) shareholders would be excited to see that the share price has had a great month, posting a 81% 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.

Since its price has surged higher, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 31x, you may consider Lorenzini Apparels as a stock to avoid entirely with its 79.2x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Recent times have been quite advantageous for Lorenzini Apparels as its earnings have been rising very briskly. It seems that many are expecting the strong 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.

Check out our latest analysis for Lorenzini Apparels

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Lorenzini Apparels will help you shine a light on its historical performance.

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 Lorenzini Apparels' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 71% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the market, which is expected to grow by 25% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Lorenzini Apparels' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On Lorenzini Apparels' P/E

Shares in Lorenzini Apparels have built up some good momentum lately, which has really inflated its 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 Lorenzini Apparels currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. 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.

Having said that, be aware Lorenzini Apparels is showing 3 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

If these risks are making you reconsider your opinion on Lorenzini Apparels, 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.