A Rising Share Price Has Us Looking Closely At Avadh Sugar & Energy Limited’s (NSE:AVADHSUGAR) P/E Ratio

Avadh Sugar & Energy (NSE:AVADHSUGAR) shares have had a really impressive month, gaining 36%, after some slippage. Looking back a bit further, we’re also happy to report the stock is up 54% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Avadh Sugar & Energy

Does Avadh Sugar & Energy Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 4.87 that sentiment around Avadh Sugar & Energy isn’t particularly high. We can see in the image below that the average P/E (13.5) for companies in the food industry is higher than Avadh Sugar & Energy’s P/E.

NSEI:AVADHSUGAR Price Estimation Relative to Market, January 3rd 2020
NSEI:AVADHSUGAR Price Estimation Relative to Market, January 3rd 2020

This suggests that market participants think Avadh Sugar & Energy will underperform other companies in its industry. Since the market seems unimpressed with Avadh Sugar & Energy, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

In the last year, Avadh Sugar & Energy grew EPS like Taylor Swift grew her fan base back in 2010; the 483% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down per year over 3 years.

Remember: P/E Ratios Don’t Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Avadh Sugar & Energy’s Balance Sheet Tell Us?

Avadh Sugar & Energy’s net debt is considerable, at 290% of its market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On Avadh Sugar & Energy’s P/E Ratio

Avadh Sugar & Energy has a P/E of 4.9. That’s below the average in the IN market, which is 13.4. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What we know for sure is that investors are becoming less uncomfortable about Avadh Sugar & Energy’s prospects, since they have pushed its P/E ratio from 3.6 to 4.9 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you’re more sensitive to price, then you may feel the opportunity has passed.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Avadh Sugar & Energy may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.