Why Investors Shouldn't Be Surprised By Dr. Reddy's Laboratories Limited's (NSE:DRREDDY) Low P/E

With a price-to-earnings (or "P/E") ratio of 19x 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 30x and even P/E's higher than 56x 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 superior to most other companies of late, Dr. Reddy's Laboratories has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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Is There Any Growth For Dr. Reddy's Laboratories?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 64% last year. The latest three year period has also seen an excellent 230% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 2.0% per annum over the next three years. With the market predicted to deliver 19% growth each year, the company is positioned for a weaker earnings result.

With this information, we can see why Dr. Reddy's Laboratories is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

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.

We've established that Dr. Reddy's Laboratories maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Dr. Reddy's Laboratories with six simple checks.

If these risks are making you reconsider your opinion on Dr. Reddy's Laboratories, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.