With a price-to-earnings (or "P/E") ratio of 56.3x SRF Limited (NSE:SRF) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 32x and even P/E's lower than 18x 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.
While the market has experienced earnings growth lately, SRF's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
See our latest analysis for SRF
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 SRF's to be considered reasonable.
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 36%. As a result, earnings from three years ago have also fallen 14% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 28% per year over the next three years. That's shaping up to be materially higher than the 21% per year growth forecast for the broader market.
With this information, we can see why SRF is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
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 SRF maintains its high P/E on the strength of its forecast growth being higher than the wider market, 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. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with SRF, and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on SRF, explore our interactive list of high quality stocks to get an idea of what else is out there.
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About NSEI:SRF
SRF
Manufactures, purchases, and sells technical textiles, chemicals, packaging films, and other polymers.
Flawless balance sheet with reasonable growth potential and pays a dividend.
