PRA Health Sciences (NASDAQ:PRAH) shareholders are no doubt pleased to see that the share price has bounced 33% in the last month alone, although it is still down 15% over the last quarter. The bad news is that even after that recovery shareholders are still underwater by about 4.9% for the full year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does PRA Health Sciences’s P/E Ratio Compare To Its Peers?
PRA Health Sciences’s P/E of 23.81 indicates relatively low sentiment towards the stock. If you look at the image below, you can see PRA Health Sciences has a lower P/E than the average (32.5) in the life sciences industry classification.
Its relatively low P/E ratio indicates that PRA Health Sciences shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with PRA Health Sciences, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
In the last year, PRA Health Sciences grew EPS like Taylor Swift grew her fan base back in 2010; the 57% gain was both fast and well deserved. And earnings per share have improved by 50% annually, over the last three years. So we’d absolutely expect it to have a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does PRA Health Sciences’s Debt Impact Its P/E Ratio?
Net debt totals 18% of PRA Health Sciences’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On PRA Health Sciences’s P/E Ratio
PRA Health Sciences has a P/E of 23.8. That’s higher than the average in its market, which is 13.6. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio. What we know for sure is that investors have become much more excited about PRA Health Sciences recently, since they have pushed its P/E ratio from 17.9 to 23.8 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is ‘blood in the streets’, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than PRA Health Sciences. 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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