Getting In Cheap On Rainbow Children's Medicare Limited (NSE:RAINBOW) Is Unlikely

With a price-to-earnings (or "P/E") ratio of 46.2x Rainbow Children's Medicare Limited (NSE:RAINBOW) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 21x and even P/E's lower than 11x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Rainbow Children's Medicare certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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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 Rainbow Children's Medicare's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 37% gain to the company's bottom line. The latest three year period has also seen an excellent 178% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 20% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 21% each year, which is not materially different.

In light of this, it's curious that Rainbow Children's Medicare's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. 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

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.

We've established that Rainbow Children's Medicare currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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.

Before you take the next step, you should know about the 1 warning sign for Rainbow Children's Medicare that we have uncovered.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

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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.