ADF Foods Limited's (NSE:ADFFOODS) Shares Climb 26% But Its Business Is Yet to Catch Up

ADF Foods Limited (NSE:ADFFOODS) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 56% in the last year.

Since its price has surged higher, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 31x, you may consider ADF Foods as a stock to potentially avoid with its 39.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, ADF Foods has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for ADF Foods

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

There's an inherent assumption that a company should outperform the market for P/E ratios like ADF Foods' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 26% gain to the company's bottom line. EPS has also lifted 24% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 22% over the next year. Meanwhile, the rest of the market is forecast to expand by 24%, which is noticeably more attractive.

With this information, we find it concerning that ADF Foods is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 large bounce in ADF Foods' shares has lifted the company's P/E to a fairly high level. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that ADF Foods currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with ADF Foods.

Of course, you might also be able to find a better stock than ADF Foods. 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.