Risks Still Elevated At These Prices As Sonam Limited (NSE:SONAMLTD) Shares Dive 27%

The Sonam Limited (NSE:SONAMLTD) share price has fared very poorly over the last month, falling by a substantial 27%. Still, a bad month hasn't completely ruined the past year with the stock gaining 65%, which is great even in a bull market.

Although its price has dipped substantially, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 31x, you may still consider Sonam as a stock to potentially avoid with its 38x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Sonam certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Sonam

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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 solid growth, and importantly, perform better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 59%. Pleasingly, EPS has also lifted 37% 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 26% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Sonam's 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 Key Takeaway

Sonam's P/E hasn't come down all the way after its stock plunged. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Sonam 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. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about this 1 warning sign we've spotted with Sonam.

If you're unsure about the strength of Sonam's 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.