Unfortunately for some shareholders, the Recipharm (STO:RECI B) share price has dived 31% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 29% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Recipharm's P/E Ratio Compare To Its Peers?
Recipharm has a P/E ratio of 19.33. As you can see below Recipharm has a P/E ratio that is fairly close for the average for the pharmaceuticals industry, which is 19.3.
Recipharm's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Recipharm actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Recipharm's 109% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 15% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Recipharm's Balance Sheet Tell Us?
Net debt totals 59% of Recipharm's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Recipharm's P/E Ratio
Recipharm has a P/E of 19.3. That's higher than the average in its market, which is 14.1. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So despite the debt it is, perhaps, not unreasonable to see a high P/E ratio. Given Recipharm's P/E ratio has declined from 28.2 to 19.3 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Recipharm. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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