Tata Elxsi Limited's (NSE:TATAELXSI) price-to-earnings (or "P/E") ratio of 45.4x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 27x and even P/E's below 15x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Tata Elxsi hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Tata Elxsi
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Tata Elxsi's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 5.4% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 20% in total. 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.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% each year over the next three years. With the market predicted to deliver 19% growth per year, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Tata Elxsi 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Key Takeaway
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.
Our examination of Tata Elxsi's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Tata Elxsi with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Tata Elxsi. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Valuation is complex, but we're here to simplify it.
Discover if Tata Elxsi might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.