Improved Earnings Required Before Alphageo (India) Limited (NSE:ALPHAGEO) Stock's 28% Jump Looks Justified

Alphageo (India) Limited (NSE:ALPHAGEO) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 59%.

In spite of the firm bounce in price, Alphageo (India) may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 21.3x, since almost half of all companies in India have P/E ratios greater than 33x and even P/E's higher than 64x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Alphageo (India) has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Alphageo (India)

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Alphageo (India)'s earnings, revenue and cash flow.

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

There's an inherent assumption that a company should underperform the market for P/E ratios like Alphageo (India)'s to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 440% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 65% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's understandable that Alphageo (India)'s P/E would sit below the majority of other companies. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Alphageo (India)'s P/E

The latest share price surge wasn't enough to lift Alphageo (India)'s P/E close to the market median. 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.

As we suspected, our examination of Alphageo (India) revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Alphageo (India) (at least 2 which are concerning), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Alphageo (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.