HFCL Limited's (NSE:HFCL) 26% Share Price Surge Not Quite Adding Up

Despite an already strong run, HFCL Limited (NSE:HFCL) shares have been powering on, with a gain of 26% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 88% in the last year.

After such a large jump in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 32x, you may consider HFCL as a stock to avoid entirely with its 55.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

The recent earnings growth at HFCL would have to be considered satisfactory if not spectacular. It might be that many expect the reasonable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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.

How Is HFCL's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like HFCL's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 6.8%. The latest three year period has also seen a 23% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Comparing that to the market, which is predicted to deliver 25% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that HFCL's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On HFCL's P/E

HFCL's P/E is flying high just like its stock has during the last month. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of HFCL revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with HFCL, and understanding these should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com