Market Participants Recognise Sonam Limited's (NSE:SONAMLTD) Earnings Pushing Shares 28% Higher

Sonam Limited (NSE:SONAMLTD) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 91% in the last year.

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 31x, you may consider Sonam as a stock to avoid entirely with its 47.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Sonam's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Sonam

Although there are no analyst estimates available for Sonam, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

Sonam's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

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 6.3%. Even so, admirably EPS has lifted 165% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Comparing that to the market, which is only predicted to deliver 25% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's understandable that Sonam's P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

Shares in Sonam have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that Sonam maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. Unless the recent medium-term conditions change, they will continue to provide strong support to the share price.

It is also worth noting that we have found 2 warning signs for Sonam (1 makes us a bit uncomfortable!) that you need to take into consideration.

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