What Torrent Power Limited's (NSE:TORNTPOWER) 26% Share Price Gain Is Not Telling You

Torrent Power Limited (NSE:TORNTPOWER) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 7.7% isn't as impressive.

Since its price has surged higher, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 25x, you may consider Torrent Power as a stock to potentially avoid with its 34.7x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Our free stock report includes 2 warning signs investors should be aware of before investing in Torrent Power. Read for free now.

With earnings growth that's superior to most other companies of late, Torrent Power has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Torrent Power

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Torrent Power.

Is There Enough Growth For Torrent Power?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 27% last year. The strong recent performance means it was also able to grow EPS by 68% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 10.0% over the next year. That's shaping up to be materially lower than the 25% growth forecast for the broader market.

With this information, we find it concerning that Torrent Power is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Torrent Power shares have received a push in the right direction, but its P/E is elevated too. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Torrent Power currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Torrent Power that you should be aware of.

If you're unsure about the strength of Torrent Power's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.