Subdued Growth No Barrier To Tera Software Limited (NSE:TERASOFT) With Shares Advancing 32%

The Tera Software Limited (NSE:TERASOFT) share price has done very well over the last month, posting an excellent gain of 32%. The last 30 days were the cherry on top of the stock's 412% gain in the last year, which is nothing short of spectacular.

Following the firm bounce in price, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 27x, you may consider Tera Software as a stock to potentially avoid with its 40.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Recent times have been quite advantageous for Tera Software as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Tera Software

Although there are no analyst estimates available for Tera Software, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Tera Software's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 110% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 25% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Tera Software's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

The large bounce in Tera Software's shares has lifted the company's P/E to a fairly high level. 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 Tera Software currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about this 1 warning sign we've spotted with Tera Software.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.