Gujarat State Fertilizers & Chemicals Limited (NSE:GSFC) Soars 27% But It's A Story Of Risk Vs Reward

Gujarat State Fertilizers & Chemicals Limited (NSE:GSFC) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Looking back a bit further, it's encouraging to see the stock is up 64% in the last year.

Although its price has surged higher, Gujarat State Fertilizers & Chemicals' price-to-earnings (or "P/E") ratio of 13x might still make it look like a strong buy right now compared to the market in India, where around half of the companies have P/E ratios above 32x and even P/E's above 60x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

As an illustration, earnings have deteriorated at Gujarat State Fertilizers & Chemicals over the last year, which is not ideal at all. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

View our latest analysis for Gujarat State Fertilizers & Chemicals

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

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

In order to justify its P/E ratio, Gujarat State Fertilizers & Chemicals would need to produce anemic growth that's substantially trailing the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 42%. Even so, admirably EPS has lifted 111% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 24% shows it's noticeably more attractive on an annualised basis.

With this information, we find it odd that Gujarat State Fertilizers & Chemicals is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Key Takeaway

Shares in Gujarat State Fertilizers & Chemicals are going to need a lot more upward momentum to get the company's P/E out of its slump. 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 Gujarat State Fertilizers & Chemicals currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.

Having said that, be aware Gujarat State Fertilizers & Chemicals is showing 2 warning signs in our investment analysis, you should know about.

If you're unsure about the strength of Gujarat State Fertilizers & Chemicals' 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.