Improved Earnings Required Before Tata Chemicals Limited (NSE:TATACHEM) Stock's 33% Jump Looks Justified

Tata Chemicals Limited (NSE:TATACHEM) shareholders have had their patience rewarded with a 33% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 32%.

In spite of the firm bounce in price, Tata Chemicals' price-to-earnings (or "P/E") ratio of 18.4x might still make it look like a buy right now compared to the market in India, where around half of the companies have P/E ratios above 31x and even P/E's above 57x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Tata Chemicals' earnings have gone into reverse gear, which is not great. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If you still like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Tata Chemicals

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

Tata Chemicals' P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than 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 13%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 324% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 38% as estimated by the seven analysts watching the company. Meanwhile, the broader market is forecast to expand by 24%, which paints a poor picture.

With this information, we are not surprised that Tata Chemicals 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

Despite Tata Chemicals' shares building up a head of steam, its P/E still lags most other companies. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Tata Chemicals' 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.

It is also worth noting that we have found 1 warning sign for Tata Chemicals that you need to take into consideration.

If these risks are making you reconsider your opinion on Tata Chemicals, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.