HFCL Limited's (NSE:HFCL) Popularity With Investors Under Threat As Stock Sinks 29%

HFCL Limited (NSE:HFCL) shareholders won't be pleased to see that the share price has had a very rough month, dropping 29% and undoing the prior period's positive performance. Looking at the bigger picture, even after this poor month the stock is up 77% in the last year.

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 33x, you may still consider HFCL as a stock to potentially avoid with its 44.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

HFCL has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for HFCL

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on HFCL's earnings, revenue and cash flow.

How Is HFCL's Growth Trending?

There's an inherent assumption that a company should 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 13%. The solid recent performance means it was also able to grow EPS by 8.1% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

This is in contrast to the rest of the market, which is expected to grow by 26% over the next year, materially higher than the company's recent medium-term annualised growth rates.

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 fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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

There's still some solid strength behind HFCL's P/E, if not its share price lately. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that HFCL currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with HFCL, and understanding should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.