Sotac Pharmaceuticals Limited's (NSE:SOTAC) 31% Price Boost Is Out Of Tune With Earnings

Sotac Pharmaceuticals Limited (NSE:SOTAC) shareholders have had their patience rewarded with a 31% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 29% 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 Sotac Pharmaceuticals as a stock to potentially avoid with its 39.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Sotac Pharmaceuticals has been doing very well. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Sotac Pharmaceuticals

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Sotac Pharmaceuticals will help you shine a light on its historical performance.

How Is Sotac Pharmaceuticals' Growth Trending?

In order to justify its P/E ratio, Sotac Pharmaceuticals would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 37%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the market, which is expected to grow by 25% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Sotac Pharmaceuticals is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Sotac Pharmaceuticals shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Sotac Pharmaceuticals currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 5 warning signs for Sotac Pharmaceuticals (of which 3 don't sit too well with us!) you should know about.

Of course, you might also be able to find a better stock than Sotac Pharmaceuticals. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com