What Central Depository Services (India) Limited's (NSE:CDSL) 27% Share Price Gain Is Not Telling You

Despite an already strong run, Central Depository Services (India) Limited (NSE:CDSL) shares have been powering on, with a gain of 27% in the last thirty days. The last 30 days bring the annual gain to a very sharp 56%.

After such a large jump in price, Central Depository Services (India)'s price-to-earnings (or "P/E") ratio of 66.8x 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 28x and even P/E's below 16x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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Recent times have been advantageous for Central Depository Services (India) as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Central Depository Services (India)

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Central Depository Services (India).

Does Growth Match The High P/E?

In order to justify its P/E ratio, Central Depository Services (India) would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 26%. The strong recent performance means it was also able to grow EPS by 69% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 13% per annum during the coming three years according to the eleven analysts following the company. With the market predicted to deliver 21% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Central Depository Services (India)'s P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

The strong share price surge has got Central Depository Services (India)'s P/E rushing to great heights as well. 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 much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Central Depository Services (India) with six simple checks on some of these key factors.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.