Abbott India Limited's (NSE:ABBOTINDIA) price-to-earnings (or "P/E") ratio of 49.6x might make it look like a sell right now compared to the market in India, where around half of the companies have P/E ratios below 34x and even P/E's below 19x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Recent times haven't been advantageous for Abbott India as its earnings have been rising slower than most other companies. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.
Check out our latest analysis for Abbott India
Want the full picture on analyst estimates for the company? Then our free report on Abbott India will help you uncover what's on the horizon.There's an inherent assumption that a company should outperform the market for P/E ratios like Abbott India's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 20% last year. The latest three year period has also seen an excellent 75% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 8.6% per annum as estimated by the four analysts watching the company. That's shaping up to be materially lower than the 20% per annum growth forecast for the broader market.
In light of this, it's alarming that Abbott India's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Abbott India currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Abbott India with six simple checks will allow you to discover any risks that could be an issue.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.