Magellanic Cloud Limited (NSE:MCLOUD) Not Lagging Market On Growth Or Pricing

Magellanic Cloud Limited's (NSE:MCLOUD) price-to-earnings (or "P/E") ratio of 41.9x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 27x and even P/E's below 15x are quite common. 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.

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For example, consider that Magellanic Cloud's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Magellanic Cloud

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Magellanic Cloud's earnings, revenue and cash flow.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like Magellanic Cloud'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 5.8%. Even so, admirably EPS has lifted 128% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 25% shows it's noticeably more attractive on an annualised basis.

In light of this, it's understandable that Magellanic Cloud's P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Bottom Line On Magellanic Cloud's P/E

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 Magellanic Cloud 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 1 warning sign with Magellanic Cloud, and understanding 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.