R Systems International Limited's (NSE:RSYSTEMS) 25% Share Price Surge Not Quite Adding Up

R Systems International Limited (NSE:RSYSTEMS) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.

Since its price has surged higher, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 29x, you may consider R Systems International as a stock to potentially avoid with its 34.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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With earnings growth that's inferior to most other companies of late, R Systems International has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

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Is There Enough Growth For R Systems International?

The only time you'd be truly comfortable seeing a P/E as high as R Systems International's is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 8.1% last year. Still, lamentably EPS has fallen 2.2% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 16% per annum during the coming three years according to the only analyst following the company. Meanwhile, the rest of the market is forecast to expand by 21% each year, which is noticeably more attractive.

In light of this, it's alarming that R Systems International's 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 R Systems International's P/E

The large bounce in R Systems International's shares has lifted the company's P/E to a fairly high level. 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.

We've established that R Systems International 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's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with R Systems International, and understanding should be part of your investment process.

If you're unsure about the strength of R Systems International's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.