Megastar Foods Limited's (NSE:MEGASTAR) Popularity With Investors Is Under Threat From Overpricing

Megastar Foods Limited's (NSE:MEGASTAR) price-to-earnings (or "P/E") ratio of 75.7x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 26x and even P/E's below 15x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

We've discovered 3 warning signs about Megastar Foods. View them for free.

For example, consider that Megastar Foods' financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out 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.

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

In order to justify its P/E ratio, Megastar Foods would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 68%. This means it has also seen a slide in earnings over the longer-term as EPS is down 46% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 24% shows it's an unpleasant look.

In light of this, it's alarming that Megastar Foods' P/E sits above the majority of other companies. 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 very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On Megastar Foods' P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Megastar Foods revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Megastar Foods (1 is potentially serious) you should be aware of.

You might be able to find a better investment than Megastar Foods. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.