Some Confidence Is Lacking In Ajanta Pharma Limited's (NSE:AJANTPHARM) P/E

With a price-to-earnings (or "P/E") ratio of 39.4x Ajanta Pharma Limited (NSE:AJANTPHARM) may be sending bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 34x and even P/E's lower than 20x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Ajanta Pharma certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Ajanta Pharma

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Ajanta Pharma's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 39% gain to the company's bottom line. Pleasingly, EPS has also lifted 31% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 13% per annum over the next three years. That's shaping up to be materially lower than the 21% per annum growth forecast for the broader market.

With this information, we find it concerning that Ajanta Pharma is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Ajanta Pharma's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Ajanta Pharma you should know about.

If you're unsure about the strength of Ajanta Pharma's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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