Recordati Industria Chimica e Farmaceutica S.p.A.'s (BIT:REC) Price Is Out Of Tune With Earnings

With a price-to-earnings (or "P/E") ratio of 27.4x Recordati Industria Chimica e Farmaceutica S.p.A. (BIT:REC) may be sending very bearish signals at the moment, given that almost half of all companies in Italy have P/E ratios under 17x and even P/E's lower than 11x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Recordati Industria Chimica e Farmaceutica's earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

Recordati Industria Chimica e Farmaceutica's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 5.1% last year. The solid recent performance means it was also able to grow EPS by 23% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 17% each year during the coming three years according to the nine analysts following the company. That's shaping up to be materially lower than the 20% per year growth forecast for the broader market.

With this information, we find it concerning that Recordati Industria Chimica e Farmaceutica is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

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.

We've established that Recordati Industria Chimica e Farmaceutica currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Recordati Industria Chimica e Farmaceutica has 2 warning signs we think you should be aware of.

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

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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.