Unpleasant Surprises Could Be In Store For Central Depository Services (India) Limited's (NSE:CDSL) Shares

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 30x, you may consider Central Depository Services (India) Limited (NSE:CDSL) as a stock to avoid entirely with its 61.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's inferior to most other companies of late, Central Depository Services (India) has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

Check out our latest analysis for Central Depository Services (India)

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Is There Enough Growth For Central Depository Services (India)?

Central Depository Services (India)'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, we see that the company managed to grow earnings per share by a handy 6.9% last year. Pleasingly, EPS has also lifted 122% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 18% per annum over the next three years. That's shaping up to be similar to the 19% per year growth forecast for the broader market.

In light of this, it's curious that Central Depository Services (India)'s P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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.

We've established that Central Depository Services (India) currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Central Depository Services (India) (of which 1 can't be ignored!) you should know about.

If these risks are making you reconsider your opinion on Central Depository Services (India), 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.