The Market Lifts Zenith Drugs Limited (NSE:ZENITHDRUG) Shares 26% But It Can Do More

Zenith Drugs Limited (NSE:ZENITHDRUG) shares have continued their recent momentum with a 26% gain in the last month alone. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Even after such a large jump in price, given about half the companies in India have price-to-earnings ratios (or "P/E's") above 35x, you may still consider Zenith Drugs as an attractive investment with its 20x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Zenith Drugs certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for Zenith Drugs

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

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

There's an inherent assumption that a company should underperform the market for P/E ratios like Zenith Drugs' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 61% gain to the company's bottom line. The latest three year period has also seen an excellent 122% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

This is in contrast to the rest of the market, which is expected to grow by 26% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Zenith Drugs' P/E sits below the majority of other companies. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Bottom Line On Zenith Drugs' P/E

The latest share price surge wasn't enough to lift Zenith Drugs' P/E close to the market median. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Zenith Drugs currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

You should always think about risks. Case in point, we've spotted 4 warning signs for Zenith Drugs you should be aware of, and 1 of them is a bit unpleasant.

If you're unsure about the strength of Zenith Drugs' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.