Earnings Not Telling The Story For ZIM Laboratories Limited (NSE:ZIMLAB) After Shares Rise 28%

ZIM Laboratories Limited (NSE:ZIMLAB) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 56% in the last year.

After such a large jump in price, ZIM Laboratories may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 36.9x, since almost half of all companies in India have P/E ratios under 31x and even P/E's lower than 17x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at ZIM Laboratories over the last year, which is not ideal at all. 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.

View our latest analysis for ZIM Laboratories

Although there are no analyst estimates available for ZIM Laboratories, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The High P/E?

ZIM Laboratories' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 32%. Still, the latest three year period has seen an excellent 104% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 24% shows it's about the same on an annualised basis.

With this information, we find it interesting that ZIM Laboratories is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent earnings trends would weigh down the share price eventually.

The Final Word

The large bounce in ZIM Laboratories' shares has lifted the company's P/E to a fairly high level. 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 ZIM Laboratories revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. Right now we are uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for ZIM Laboratories that you should be aware of.

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

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.