There's Reason For Concern Over Tata Elxsi Limited's (NSE:TATAELXSI) Massive 29% Price Jump

Tata Elxsi Limited (NSE:TATAELXSI) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

Since its price has surged higher, Tata Elxsi's price-to-earnings (or "P/E") ratio of 70.9x 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 34x and even P/E's below 19x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's inferior to most other companies of late, Tata Elxsi has been relatively sluggish. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Tata Elxsi

Keen to find out how analysts think Tata Elxsi's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Tata Elxsi's Growth Trending?

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 decent 3.7% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 91% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 20% per 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. 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 Bottom Line On Tata Elxsi's P/E

Tata Elxsi's P/E is flying high just like its stock has during the last month. 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. 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. Our free balance sheet analysis for Tata Elxsi with six simple checks will allow you to discover any risks that could be an issue.

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.