Megastar Foods Limited (NSE:MEGASTAR) Shares May Have Slumped 25% But Getting In Cheap Is Still Unlikely

Megastar Foods Limited (NSE:MEGASTAR) shareholders won't be pleased to see that the share price has had a very rough month, dropping 25% and undoing the prior period's positive performance. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

In spite of the heavy fall in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 20x, you may still consider Megastar Foods as a stock to potentially avoid with its 24.6x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Megastar Foods certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Megastar Foods

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Megastar Foods will help you shine a light on its historical performance.

How Is Megastar Foods' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Megastar Foods' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 36% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 38% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

This is in contrast to the rest of the market, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Megastar Foods is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

There's still some solid strength behind Megastar Foods' P/E, if not its share price lately. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Megastar Foods currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - Megastar Foods has 4 warning signs (and 3 which don't sit too well with us) we think you should know about.

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 P/E below 20x.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.