There's Reason For Concern Over Asian Paints Limited's (NSE:ASIANPAINT) Price

With a price-to-earnings (or "P/E") ratio of 64.5x Asian Paints Limited (NSE:ASIANPAINT) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 29x and even P/E's lower than 16x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Asian Paints certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Asian Paints

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Asian Paints.

Does Growth Match The High P/E?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 38% last year. The latest three year period has also seen an excellent 123% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.5% per annum over the next three years. That's shaping up to be materially lower than the 19% each year growth forecast for the broader market.

With this information, we find it concerning that Asian Paints is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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.

We've established that Asian Paints currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Asian Paints with six simple checks will allow you to discover any risks that could be an issue.

If you're unsure about the strength of Asian Paints' 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.