Tata Elxsi Limited's (NSE:TATAELXSI) Price Is Out Of Tune With Earnings

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 25x, you may consider Tata Elxsi Limited (NSE:TATAELXSI) as a stock to avoid entirely with its 45.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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While the market has experienced earnings growth lately, Tata Elxsi's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Is There Enough Growth For Tata Elxsi?

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

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Still, the latest three year period has seen an excellent 43% overall rise in EPS, in spite of its uninspiring short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 10% per annum over the next three years. That's shaping up to be materially lower than the 20% each year growth forecast for the broader market.

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. 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.

What We Can Learn From Tata Elxsi's 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 Tata Elxsi 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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Tata Elxsi with six simple checks on some of these key factors.

If you're unsure about the strength of Tata Elxsi'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.