Tata Communications Limited's (NSE:TATACOMM) P/E Is On The Mark

When close to half the companies in India have price-to-earnings ratios (or "P/E's") below 25x, you may consider Tata Communications Limited (NSE:TATACOMM) as a stock to potentially avoid with its 37.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Tata Communications could be doing better as it's been growing earnings less than most other companies lately. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

The only time you'd be truly comfortable seeing a P/E as high as Tata Communications' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a decent 9.3% gain to the company's bottom line. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 25% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 58% as estimated by the seven analysts watching the company. That's shaping up to be materially higher than the 25% growth forecast for the broader market.

With this information, we can see why Tata Communications is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Tata Communications 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. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Tata Communications (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

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.