Earnings Not Telling The Story For Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) After Shares Rise 26%

Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) shareholders have had their patience rewarded with a 26% share price jump in the last month. Taking a wider view, although not as strong as the last month, the full year gain of 16% is also fairly reasonable.

Since its price has surged higher, Aarey Drugs & Pharmaceuticals' price-to-earnings (or "P/E") ratio of 47.6x 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 28x and even P/E's below 16x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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For instance, Aarey Drugs & Pharmaceuticals' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View 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.

Is There Enough Growth For Aarey Drugs & Pharmaceuticals?

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.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. This means it has also seen a slide in earnings over the longer-term as EPS is down 16% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 25% shows it's an unpleasant look.

In light of this, it's alarming that Aarey Drugs & Pharmaceuticals' P/E sits above the majority of other companies. 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.

What We Can Learn From Aarey Drugs & Pharmaceuticals' P/E?

Aarey Drugs & Pharmaceuticals' 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.

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. 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.

You need to take note of risks, for example - Aarey Drugs & Pharmaceuticals has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Of course, you might also be able to find a better stock than Aarey Drugs & Pharmaceuticals. 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.