What You Can Learn From Sonata Software Limited's (NSE:SONATSOFTW) P/EAfter Its 29% Share Price Crash

Sonata Software Limited (NSE:SONATSOFTW) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. Looking at the bigger picture, even after this poor month the stock is up 27% in the last year.

Although its price has dipped substantially, Sonata Software may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 48.6x, since almost half of all companies in India have P/E ratios under 31x and even P/E's lower than 17x 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.

While the market has experienced earnings growth lately, Sonata Software's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for Sonata Software

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Sonata Software.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Sonata Software would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 32%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 26% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next year should generate growth of 83% as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 24%, which is noticeably less attractive.

In light of this, it's understandable that Sonata Software's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Sonata Software's P/E

A significant share price dive has done very little to deflate Sonata Software's very lofty P/E. 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 Sonata Software maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

We don't want to rain on the parade too much, but we did also find 4 warning signs for Sonata Software that you need to be mindful of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.