Tech Mahindra Limited (NSE:TECHM) Not Lagging Market On Growth Or Pricing

With a price-to-earnings (or "P/E") ratio of 40.1x Tech Mahindra Limited (NSE:TECHM) may be sending bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 28x and even P/E's lower than 16x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Tech Mahindra certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Tech Mahindra

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Tech Mahindra.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Tech Mahindra would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 33%. However, this wasn't enough as the latest three year period has seen a very unpleasant 28% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 30% each year over the next three years. That's shaping up to be materially higher than the 18% each year growth forecast for the broader market.

In light of this, it's understandable that Tech Mahindra's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Tech Mahindra'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 Tech Mahindra maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Tech Mahindra that you should be aware of.

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.