Why Investors Shouldn't Be Surprised By Rama Steel Tubes Limited's (NSE:RAMASTEEL) 25% Share Price Surge

Rama Steel Tubes Limited (NSE:RAMASTEEL) shares have continued their recent momentum with a 25% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

After such a large jump in price, Rama Steel Tubes may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 74.5x, since almost half of all companies in India have P/E ratios under 31x and even P/E's lower than 17x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Rama Steel Tubes certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Rama Steel Tubes

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

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 62%. The latest three year period has also seen an excellent 1,123% 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.

Comparing that to the market, which is only predicted to deliver 25% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

With this information, we can see why Rama Steel Tubes is trading at such a high P/E compared to the market. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

Shares in Rama Steel Tubes have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that Rama Steel Tubes maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Rama Steel Tubes (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

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.