Unpleasant Surprises Could Be In Store For Escorts Kubota Limited's (NSE:ESCORTS) Shares

With a price-to-earnings (or "P/E") ratio of 34.5x Escorts Kubota Limited (NSE:ESCORTS) may be sending bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 25x and even P/E's lower than 14x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's inferior to most other companies of late, Escorts Kubota has been relatively sluggish. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

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Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a decent 5.4% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 86% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 9.7% each year as estimated by the analysts watching the company. With the market predicted to deliver 20% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Escorts Kubota 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.

What We Can Learn From Escorts Kubota's P/E?

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.

Our examination of Escorts Kubota's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Escorts Kubota has 1 warning sign we think you should be aware of.

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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.