Insufficient Growth At Dr. Reddy's Laboratories Limited (NSE:DRREDDY) Hampers Share Price

With a price-to-earnings (or "P/E") ratio of 19.1x Dr. Reddy's Laboratories Limited (NSE:DRREDDY) may be sending bullish signals at the moment, given that almost half of all companies in India have P/E ratios greater than 33x and even P/E's higher than 61x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings growth that's inferior to most other companies of late, Dr. Reddy's Laboratories has been relatively sluggish. It seems that many are expecting the uninspiring earnings performance to persist, which has repressed the P/E. If you still like the company, you'd be hoping earnings don't get any worse and that you could pick up some stock while it's out of favour.

See our latest analysis for Dr. Reddy's Laboratories

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

In order to justify its P/E ratio, Dr. Reddy's Laboratories would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 17% gain to the company's bottom line. Pleasingly, EPS has also lifted 223% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 3.1% per annum over the next three years. With the market predicted to deliver 19% growth per annum, that's a disappointing outcome.

With this information, we are not surprised that Dr. Reddy's Laboratories is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

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.

As we suspected, our examination of Dr. Reddy's Laboratories' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

Plus, you should also learn about this 1 warning sign we've spotted with Dr. Reddy's Laboratories.

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.