R & B Denims Limited's (NSE:RNBDENIMS) 25% Share Price Surge Not Quite Adding Up

R & B Denims Limited (NSE:RNBDENIMS) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, given close to half the companies in India have price-to-earnings ratios (or "P/E's") below 28x, you may consider R & B Denims as a stock to avoid entirely with its 46.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.

For instance, R & B Denims' receding earnings in recent times would have to be some food for thought. 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.

Check out our latest analysis for R & B Denims

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on R & B Denims' earnings, revenue and cash flow.

Is There Enough Growth For R & B Denims?

In order to justify its P/E ratio, R & B Denims would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 8.6%. As a result, earnings from three years ago have also fallen 25% overall. 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.

With this information, we find it concerning that R & B Denims is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Key Takeaway

The strong share price surge has got R & B Denims' 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 R & B Denims currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with R & B Denims (at least 1 which doesn't sit too well with us), and understanding them should be part of your investment process.

You might be able to find a better investment than R & B Denims. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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.