Tata Consultancy Services Limited's (NSE:TCS) Share Price Could Signal Some Risk

It's not a stretch to say that Tata Consultancy Services Limited's (NSE:TCS) price-to-earnings (or "P/E") ratio of 34.4x right now seems quite "middle-of-the-road" compared to the market in India, where the median P/E ratio is around 35x. 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.

Tata Consultancy Services could be doing better as it's been growing earnings less than most other companies lately. One possibility is that the P/E is moderate because investors think this lacklustre earnings performance will turn around. If not, then existing shareholders may be a little nervous about the viability of the share price.

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Is There Some Growth For Tata Consultancy Services?

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

If we review the last year of earnings growth, the company posted a worthy increase of 7.8%. Pleasingly, EPS has also lifted 40% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 12% each year over the next three years. With the market predicted to deliver 20% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's curious that Tata Consultancy Services' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Tata Consultancy Services' P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Tata Consultancy Services' analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Tata Consultancy Services with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Tata Consultancy Services, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.