Foseco India Limited's (NSE:FOSECOIND) 33% Price Boost Is Out Of Tune With Earnings

Despite an already strong run, Foseco India Limited (NSE:FOSECOIND) shares have been powering on, with a gain of 33% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 33% in the last year.

Since its price has surged higher, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 27x, you may consider Foseco India as a stock to avoid entirely with its 50.7x 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.

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The earnings growth achieved at Foseco India over the last year would be more than acceptable for most companies. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Check out our latest analysis for Foseco India

Although there are no analyst estimates available for Foseco India, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like Foseco India's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 25% gain to the company's bottom line. The latest three year period has also seen an excellent 105% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

It's interesting to note that the rest of the market is similarly expected to grow by 25% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

In light of this, it's curious that Foseco India's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Nevertheless, they may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

The strong share price surge has got Foseco India's P/E rushing to great heights as well. 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.

Our examination of Foseco India revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. When we see average earnings with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Foseco India (at least 2 which are a bit unpleasant), and understanding these should be part of your investment process.

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