Insufficient Growth At NATCO Pharma Limited (NSE:NATCOPHARM) Hampers Share Price

When close to half the companies in India have price-to-earnings ratios (or “P/E’s”) above 25x, you may consider NATCO Pharma Limited (NSE:NATCOPHARM) as a highly attractive investment with its 10x P/E ratio. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

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NATCO Pharma could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. The P/E is probably low because investors think this poor earnings performance isn’t going to get any better. If you still like the company, you’d be hoping this isn’t the case so that you could potentially pick up some stock while it’s out of favour.

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Does Growth Match The Low P/E?

NATCO Pharma’s P/E ratio would be typical for a company that’s expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Taking a look back first, the company’s earnings per share growth last year wasn’t something to get excited about as it posted a disappointing decline of 21%. Still, the latest three year period has seen an excellent 285% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 20% each year during the coming three years according to the eleven analysts following the company. That’s not great when the rest of the market is expected to grow by 20% each year.

In light of this, it’s understandable that NATCO Pharma’s P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

Typically, we’d caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of NATCO Pharma’s analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won’t provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we’ve spotted 2 warning signs for NATCO Pharma you should be aware of, and 1 of them doesn’t sit too well with us.

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

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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.