Mahanagar Gas Limited's (NSE:MGL) Price Is Right But Growth Is Lacking

Mahanagar Gas Limited's (NSE:MGL) price-to-earnings (or "P/E") ratio of 11.6x might make it look like a strong buy right now compared to the market in India, where around half of the companies have P/E ratios above 32x and even P/E's above 58x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Mahanagar Gas certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Mahanagar Gas

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Is There Any Growth For Mahanagar Gas?

Mahanagar Gas' P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered an exceptional 98% gain to the company's bottom line. Pleasingly, EPS has also lifted 126% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 10% per annum during the coming three years according to the analysts following the company. Meanwhile, the broader market is forecast to expand by 20% per annum, which paints a poor picture.

With this information, we are not surprised that Mahanagar Gas is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Mahanagar Gas' P/E

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.

We've established that Mahanagar Gas maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Mahanagar Gas (1 is significant) you should be aware of.

Of course, you might also be able to find a better stock than Mahanagar Gas. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.