Newgen Software Technologies Limited's (NSE:NEWGEN) 28% Price Boost Is Out Of Tune With Earnings

Newgen Software Technologies Limited (NSE:NEWGEN) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 8.7% isn't as impressive.

Following the firm bounce in price, Newgen Software Technologies may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 48.4x, since almost half of all companies in India have P/E ratios under 25x and even P/E's lower than 14x are not unusual. 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.

Our free stock report includes 2 warning signs investors should be aware of before investing in Newgen Software Technologies. Read for free now.

Recent times have been advantageous for Newgen Software Technologies as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out 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.

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 Newgen Software Technologies' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 25% gain to the company's bottom line. Pleasingly, EPS has also lifted 89% 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.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 17% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 20% each year, which is noticeably more attractive.

In light of this, it's alarming that Newgen Software Technologies' P/E sits above the majority of other companies. 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 Bottom Line On Newgen Software Technologies' P/E

Newgen Software Technologies' P/E is flying high just like its stock has during the last month. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. 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.

It is also worth noting that we have found 2 warning signs for Newgen Software Technologies (1 is potentially serious!) that you need to take into consideration.

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).

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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.