HFCL Limited (NSE:HFCL) Shares May Have Slumped 26% But Getting In Cheap Is Still Unlikely

To the annoyance of some shareholders, HFCL Limited (NSE:HFCL) shares are down a considerable 26% in the last month, which continues a horrid run for the company. Indeed, the recent drop has reduced its annual gain to a relatively sedate 5.3% over the last twelve months.

In spite of the heavy fall in price, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 31x, you may still consider HFCL as a stock to potentially avoid with its 35.6x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

The earnings growth achieved at HFCL over the last year would be more than acceptable for most companies. It might be that many expect the respectable 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 may be a little nervous about the viability of the share price.

View our latest analysis for HFCL

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on HFCL will help you shine a light on its historical performance.

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

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

Retrospectively, the last year delivered an exceptional 18% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

In contrast to the company, the rest of the market is expected to grow by 26% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that HFCL is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate 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 Final Word

HFCL's P/E hasn't come down all the way after its stock plunged. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of HFCL revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place 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. Take a look at our free balance sheet analysis for HFCL with six simple checks on some of these key factors.

You might be able to find a better investment than HFCL. 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.