To the annoyance of some shareholders, Bioventix (LON:BVXP) shares are down a considerable 31% in the last month. Even longer term holders have taken a real hit with the stock declining 28% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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 Bioventix’s P/E Ratio Compare To Its Peers?
Bioventix’s P/E of 23.50 indicates relatively low sentiment towards the stock. The image below shows that Bioventix has a lower P/E than the average (32.0) P/E for companies in the biotechs industry.
Bioventix’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Bioventix increased earnings per share by 3.5% last year. And its annual EPS growth rate over 5 years is 26%.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Bioventix’s Balance Sheet
Since Bioventix holds net cash of UK£6.5m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Bioventix’s P/E Ratio
Bioventix trades on a P/E ratio of 23.5, which is above its market average of 11.2. Recent earnings growth wasn’t bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will. Given Bioventix’s P/E ratio has declined from 33.9 to 23.5 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 should be looking to buy stocks that the market is wrong about. 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 Bioventix. 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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