Sonata Software Limited (NSE:SONATSOFTW) Stock's 27% Dive Might Signal An Opportunity But It Requires Some Scrutiny

Sonata Software Limited (NSE:SONATSOFTW) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 43% in that time.

Even after such a large drop in price, it's still not a stretch to say that Sonata Software's price-to-earnings (or "P/E") ratio of 29x right now seems quite "middle-of-the-road" compared to the market in India, where the median P/E ratio is around 29x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Recent times have been advantageous for Sonata Software as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

See our latest analysis for Sonata Software

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

Is There Some Growth For Sonata Software?

There's an inherent assumption that a company should be matching the market for P/E ratios like Sonata Software's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 37% last year. The latest three year period has also seen a 19% overall rise in EPS, aided extensively by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 23% per annum as estimated by the eight analysts watching the company. That's shaping up to be materially higher than the 18% each year growth forecast for the broader market.

In light of this, it's curious that Sonata Software's P/E sits in line with the majority of other companies. It may be that most investors aren't convinced the company can achieve future growth expectations.

The Key Takeaway

Following Sonata Software's share price tumble, its P/E is now hanging on to the median market 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.

Our examination of Sonata Software's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E as much as we would have predicted. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Sonata Software that you need to be mindful of.

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).

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.