Investors Appear Satisfied With Alkem Laboratories Limited's (NSE:ALKEM) Prospects

Alkem Laboratories Limited's (NSE:ALKEM) price-to-earnings (or "P/E") ratio of 42.2x might make it look like a 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. 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.

Recent times have been advantageous for Alkem Laboratories as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

In order to justify its P/E ratio, Alkem Laboratories would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 31% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 2.2% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 23% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 19% per annum, which is noticeably less attractive.

In light of this, it's understandable that Alkem Laboratories' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Alkem Laboratories' P/E

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 Alkem Laboratories maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - Alkem Laboratories has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Alkem Laboratories' 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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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.