Megastar Foods Limited's (NSE:MEGASTAR) 26% Share Price Surge Not Quite Adding Up

Megastar Foods Limited (NSE:MEGASTAR) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 3.0% isn't as impressive.

Following the firm bounce in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 34x, you may consider Megastar Foods as a stock to avoid entirely with its 54.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Megastar Foods' financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Megastar Foods

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 Megastar Foods' earnings, revenue and cash flow.

Is There Enough Growth For Megastar Foods?

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

Retrospectively, the last year delivered a frustrating 39% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 35% 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.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 25% shows it's noticeably less attractive on an annualised basis.

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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Megastar Foods' P/E

Megastar Foods' P/E is flying high just like its stock has during the last month. 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 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 6 warning signs for Megastar Foods you should be aware of, and 2 of them don't sit too well with us.

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

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