Improved Earnings Required Before National Aluminium Company Limited (NSE:NATIONALUM) Shares Find Their Feet

National Aluminium Company Limited's (NSE:NATIONALUM) price-to-earnings (or "P/E") ratio of 7.6x might 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 28x and even P/E's above 54x 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.

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Recent times have been advantageous for National Aluminium as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for National Aluminium

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

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

In order to justify its P/E ratio, National Aluminium would need to produce anemic growth that's substantially trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 156% last year. The strong recent performance means it was also able to grow EPS by 81% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 5.9% per year as estimated by the ten analysts watching the company. With the market predicted to deliver 19% growth per annum, that's a disappointing outcome.

With this information, we are not surprised that National Aluminium is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

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.

As we suspected, our examination of National Aluminium's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

There are also other vital risk factors to consider and we've discovered 2 warning signs for National Aluminium (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.