There's Reason For Concern Over Unichem Laboratories Limited's (NSE:UNICHEMLAB) Massive 28% Price Jump

Unichem Laboratories Limited (NSE:UNICHEMLAB) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 9.8% over the last year.

After such a large jump in price, Unichem Laboratories' price-to-earnings (or "P/E") ratio of 63.7x might make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 21x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Unichem Laboratories' financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Unichem Laboratories

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Unichem Laboratories' earnings, revenue and cash flow.

Is There Enough Growth For Unichem Laboratories?

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

Retrospectively, the last year delivered a frustrating 3.7% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Unichem Laboratories' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From Unichem Laboratories' P/E?

Shares in Unichem Laboratories have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Unichem Laboratories revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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.

Before you take the next step, you should know about the 1 warning sign for Unichem Laboratories that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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.