Raia Drogasil S.A.'s (BVMF:RADL3) 28% Dip Still Leaving Some Shareholders Feeling Restless Over Its P/ERatio

Raia Drogasil S.A. (BVMF:RADL3) shareholders won't be pleased to see that the share price has had a very rough month, dropping 28% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 40% share price drop.

Even after such a large drop in price, Raia Drogasil's price-to-earnings (or "P/E") ratio of 22.6x might still make it look like a strong sell right now compared to the market in Brazil, where around half of the companies have P/E ratios below 9x and even P/E's below 6x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Raia Drogasil certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. 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?

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

If we review the last year of earnings growth, the company posted a worthy increase of 14%. The latest three year period has also seen an excellent 64% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 14% each year over the next three years. That's shaping up to be similar to the 14% per annum growth forecast for the broader market.

In light of this, it's curious that Raia Drogasil's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Raia Drogasil's P/E

A significant share price dive has done very little to deflate Raia Drogasil's very lofty P/E. 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 Raia Drogasil currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Raia Drogasil that you need to be mindful of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.