Birlasoft Limited's (NSE:BSOFT) Share Price Matching Investor Opinion

With a price-to-earnings (or "P/E") ratio of 54x Birlasoft Limited (NSE:BSOFT) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 29x and even P/E's lower than 16x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Birlasoft'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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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 Birlasoft's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 43% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the eleven 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 19% per annum growth forecast for the broader market.

In light of this, it's understandable that Birlasoft's P/E sits above the majority of other companies. 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.

As we suspected, our examination of Birlasoft's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Birlasoft you should know about.

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.