Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) Stock Rockets 28% As Investors Are Less Pessimistic Than Expected

Those holding Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) shares would be relieved that the share price has rebounded 28% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. The last 30 days bring the annual gain to a very sharp 84%.

After such a large jump in price, Aarey Drugs & Pharmaceuticals' price-to-earnings (or "P/E") ratio of 47.4x 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 31x and even P/E's below 17x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Earnings have risen at a steady rate over the last year for Aarey Drugs & Pharmaceuticals, which is generally not a bad outcome. One possibility is that the P/E is high because investors think this good earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for Aarey Drugs & Pharmaceuticals

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 Aarey Drugs & Pharmaceuticals' earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Aarey Drugs & Pharmaceuticals' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 3.1% last year. Still, lamentably EPS has fallen 61% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 24% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Aarey Drugs & Pharmaceuticals 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. 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

The strong share price surge has got Aarey Drugs & Pharmaceuticals' P/E rushing to great heights as well. 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.

We've established that Aarey Drugs & Pharmaceuticals currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Aarey Drugs & Pharmaceuticals (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.

You might be able to find a better investment than Aarey Drugs & Pharmaceuticals. 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.