Zydus Wellness Limited's (NSE:ZYDUSWELL) Popularity With Investors Is Under Threat From Overpricing

With a price-to-earnings (or "P/E") ratio of 36x Zydus Wellness Limited (NSE:ZYDUSWELL) may be sending bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 30x and even P/E's lower than 17x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings growth that's inferior to most other companies of late, Zydus Wellness has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

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How Is Zydus Wellness' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Zydus Wellness' is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a worthy increase of 14%. EPS has also lifted 11% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 19% per annum over the next three years. With the market predicted to deliver 19% growth per annum, the company is positioned for a comparable earnings result.

In light of this, it's curious that Zydus Wellness' 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. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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 Zydus Wellness' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Zydus Wellness, and understanding should be part of your investment process.

You might be able to find a better investment than Zydus Wellness. 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).

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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.