More Unpleasant Surprises Could Be In Store For Newgen Software Technologies Limited's (NSE:NEWGEN) Shares After Tumbling 26%

Newgen Software Technologies Limited (NSE:NEWGEN) shares have had a horrible month, losing 26% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 21% in that time.

In spite of the heavy fall in price, Newgen Software Technologies' price-to-earnings (or "P/E") ratio of 37.6x might still make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 29x and even P/E's below 16x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

Recent times have been advantageous for Newgen Software Technologies as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Newgen Software Technologies

Want the full picture on analyst estimates for the company? Then our free report on Newgen Software Technologies will help you uncover what's on the horizon.

How Is Newgen Software Technologies' Growth Trending?

In order to justify its P/E ratio, Newgen Software Technologies would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 18% last year. Pleasingly, EPS has also lifted 94% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 15% each year as estimated by the five analysts watching the company. With the market predicted to deliver 22% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Newgen Software Technologies is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Newgen Software Technologies' P/E hasn't come down all the way after its stock plunged. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Newgen Software Technologies currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Newgen Software Technologies, and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than Newgen Software Technologies. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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.