ITC Limited's (NSE:ITC) Shares May Have Run Too Fast Too Soon

There wouldn't be many who think ITC Limited's (NSE:ITC) price-to-earnings (or "P/E") ratio of 26.9x is worth a mention when the median P/E in India is similar at about 27x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

We've discovered 1 warning sign about ITC. View them for free.

While the market has experienced earnings growth lately, ITC's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is moderate because investors think this poor earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

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How Is ITC's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 2.2% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 34% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Looking ahead now, EPS is anticipated to climb by 9.8% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 21% each year, which is noticeably more attractive.

In light of this, it's curious that ITC's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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

You should always think about risks. Case in point, we've spotted 1 warning sign for ITC you should be aware of.

If you're unsure about the strength of ITC's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.