Earnings Not Telling The Story For Davangere Sugar Company Limited (NSE:DAVANGERE) After Shares Rise 28%

Davangere Sugar Company Limited (NSE:DAVANGERE) shares have continued their recent momentum with a 28% gain in the last month alone. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 14% in the last twelve months.

After such a large jump in price, Davangere Sugar's price-to-earnings (or "P/E") ratio of 55.3x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 24x and even P/E's below 13x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

For example, consider that Davangere Sugar's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Davangere Sugar

Although there are no analyst estimates available for Davangere Sugar, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Growth For Davangere Sugar?

Davangere Sugar's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 5.7%. This means it has also seen a slide in earnings over the longer-term as EPS is down 59% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 25% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Davangere Sugar's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

The strong share price surge has got Davangere Sugar's P/E rushing to great heights as well. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Davangere Sugar currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, 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.

Having said that, be aware Davangere Sugar is showing 4 warning signs in our investment analysis, and 3 of those shouldn't be ignored.

If these risks are making you reconsider your opinion on Davangere Sugar, explore our interactive list of high quality stocks to get an idea of what else is out there.

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

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.