Unpleasant Surprises Could Be In Store For Tata Consultancy Services Limited's (NSE:TCS) Shares

There wouldn't be many who think Tata Consultancy Services Limited's (NSE:TCS) price-to-earnings (or "P/E") ratio of 33.9x is worth a mention when the median P/E in India is similar at about 33x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

With earnings growth that's inferior to most other companies of late, Tata Consultancy Services has been relatively sluggish. One possibility is that the P/E is moderate because investors think this lacklustre earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

See our latest analysis for Tata Consultancy Services

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How Is Tata Consultancy Services' Growth Trending?

In order to justify its P/E ratio, Tata Consultancy Services would need to produce growth that's similar to the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.2% last year. This was backed up an excellent period prior to see EPS up by 33% 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 13% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 19% per annum growth forecast for the broader market.

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 Final Word

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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Tata Consultancy Services with six simple checks on some of these key factors.

You might be able to find a better investment than Tata Consultancy Services. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.