There's Reason For Concern Over R M Drip and Sprinklers Systems Limited's (NSE:RMDRIP) Massive 38% Price Jump

Despite an already strong run, R M Drip and Sprinklers Systems Limited (NSE:RMDRIP) shares have been powering on, with a gain of 38% in the last thirty days. The last month tops off a massive increase of 279% in the last year.

Since its price has surged higher, R M Drip and Sprinklers Systems' price-to-earnings (or "P/E") ratio of 76.7x 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 32x and even P/E's below 18x 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.

Recent times have been quite advantageous for R M Drip and Sprinklers Systems as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for R M Drip and Sprinklers Systems

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on R M Drip and Sprinklers Systems will help you shine a light on its historical performance.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like R M Drip and Sprinklers Systems' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 255%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the market, which is expected to grow by 26% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that R M Drip and Sprinklers Systems' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

R M Drip and Sprinklers Systems' P/E is flying high just like its stock has during the last month. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of R M Drip and Sprinklers Systems revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. 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.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for R M Drip and Sprinklers Systems (1 makes us a bit uncomfortable) you should be aware of.

Of course, you might also be able to find a better stock than R M Drip and Sprinklers Systems. 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.