Persistent Systems Limited's (NSE:PERSISTENT) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 23x, you may consider Persistent Systems Limited (NSE:PERSISTENT) as a stock to avoid entirely with its 50.6x P/E ratio. 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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Persistent Systems certainly has been doing a good job lately as it's been growing earnings more 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.

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Does Growth Match The High P/E?

Persistent Systems' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered an exceptional 29% gain to the company's bottom line. The latest three year period has also seen an excellent 100% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 15% each year over the next three years. That's shaping up to be materially lower than the 21% per year growth forecast for the broader market.

With this information, we find it concerning that Persistent Systems 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. 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 Persistent Systems' P/E

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 Persistent Systems 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.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Persistent Systems with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Persistent Systems, 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.