Sumitomo Chemical India Limited's (NSE:SUMICHEM) Price Is Out Of Tune With Earnings

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 26x, you may consider Sumitomo Chemical India Limited (NSE:SUMICHEM) as a stock to avoid entirely with its 42.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.

Recent earnings growth for Sumitomo Chemical India has been in line with the market. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Sumitomo Chemical India

Want the full picture on analyst estimates for the company? Then our free report on Sumitomo Chemical India will help you uncover what's on the horizon.

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

In order to justify its P/E ratio, Sumitomo Chemical India would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a worthy increase of 12%. EPS has also lifted 7.9% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 14% per annum as estimated by the six analysts watching the company. With the market predicted to deliver 20% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Sumitomo Chemical India is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Sumitomo Chemical India currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Sumitomo Chemical India with six simple checks on some of these key factors.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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.