Arihant Academy Limited's (NSE:ARIHANTACA) 25% Share Price Surge Not Quite Adding Up

Arihant Academy Limited (NSE:ARIHANTACA) shares have continued their recent momentum with a 25% gain in the last month alone. The annual gain comes to 130% following the latest surge, making investors sit up and take notice.

After such a large jump in price, Arihant Academy's price-to-earnings (or "P/E") ratio of 47x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 29x and even P/E's below 16x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's exceedingly strong of late, Arihant Academy has been doing very well. 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.

View our latest analysis for Arihant Academy

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

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

The only time you'd be truly comfortable seeing a P/E as steep as Arihant Academy's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 187% gain to the company's bottom line. The latest three year period has also seen an excellent 62% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Arihant Academy's P/E sits above the majority of other companies. 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.

What We Can Learn From Arihant Academy's P/E?

The strong share price surge has got Arihant Academy's P/E rushing to great heights as well. 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.

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

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Arihant Academy (at least 1 which is concerning), and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than Arihant Academy. 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.