Earnings Not Telling The Story For SMS Pharmaceuticals Limited (NSE:SMSPHARMA) After Shares Rise 27%

SMS Pharmaceuticals Limited (NSE:SMSPHARMA) shares have continued their recent momentum with a 27% gain in the last month alone. The last month tops off a massive increase of 139% in the last year.

After such a large jump in price, given around half the companies in India have price-to-earnings ratios (or "P/E's") below 32x, you may consider SMS Pharmaceuticals as a stock to potentially avoid with its 44.8x P/E ratio. 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.

SMS Pharmaceuticals certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for SMS Pharmaceuticals

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Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like SMS Pharmaceuticals' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 281% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 28% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that SMS Pharmaceuticals' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

SMS Pharmaceuticals' P/E is getting right up there since its shares have risen strongly. 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.

Our examination of SMS Pharmaceuticals revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for SMS Pharmaceuticals that you should be aware of.

If these risks are making you reconsider your opinion on SMS Pharmaceuticals, 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.