What Alkem Laboratories Limited's (NSE:ALKEM) P/E Is Not Telling You

It's not a stretch to say that Alkem Laboratories Limited's (NSE:ALKEM) price-to-earnings (or "P/E") ratio of 34.8x right now seems quite "middle-of-the-road" compared to the market in India, where the median P/E ratio is around 34x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been advantageous for Alkem Laboratories as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

See our latest analysis for Alkem Laboratories

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

The only time you'd be comfortable seeing a P/E like Alkem Laboratories' is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered an exceptional 80% gain to the company's bottom line. As a result, it also grew EPS by 26% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 9.5% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 21% each year, which is noticeably more attractive.

In light of this, it's curious that Alkem Laboratories' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Key Takeaway

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.

We've established that Alkem Laboratories currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for Alkem Laboratories that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.