Shareholders Should Be Pleased With Divi's Laboratories Limited's (NSE:DIVISLAB) Price

With a price-to-earnings (or "P/E") ratio of 71.2x Divi's Laboratories Limited (NSE:DIVISLAB) may be sending very bearish signals at the moment, given that almost half of all companies in India have P/E ratios under 30x and even P/E's lower than 17x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Divi's Laboratories could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Divi's Laboratories

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Divi's Laboratories.

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

In order to justify its P/E ratio, Divi's Laboratories would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 42%. The last three years don't look nice either as the company has shrunk EPS by 26% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 25% each year over the next three years. With the market only predicted to deliver 20% per annum, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Divi's 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.

What We Can Learn From Divi's Laboratories' P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Divi's Laboratories' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Divi's Laboratories you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.