What Aarey Drugs & Pharmaceuticals Limited's (NSE:AAREYDRUGS) P/E Is Not Telling You

Aarey Drugs & Pharmaceuticals Limited's (NSE:AAREYDRUGS) price-to-earnings (or "P/E") ratio of 54.3x 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 29x and even P/E's below 16x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Aarey Drugs & Pharmaceuticals' 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 Aarey Drugs & Pharmaceuticals

Although there are no analyst estimates available for Aarey Drugs & Pharmaceuticals, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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 Aarey Drugs & Pharmaceuticals' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 43% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 63% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

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 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

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

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. 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 shouldn't be ignored) 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.