Unfortunately for some shareholders, the Pharming Group (AMS:PHARM) share price has dived 33% in the last thirty days. Looking back over the last year, the stock has been a solid performer, with a gain of 15%.
Assuming nothing else has changed, a lower share price makes a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
Does Pharming Group Have A Relatively High Or Low P/E For Its Industry?
Pharming Group’s P/E of 16.03 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (33.3) for companies in the biotechs industry is higher than Pharming Group’s P/E.
Its relatively low P/E ratio indicates that Pharming Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Pharming Group increased earnings per share by a whopping 41% last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Pharming Group’s Balance Sheet Tell Us?
Pharming Group has net cash of €21m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Pharming Group’s P/E Ratio
Pharming Group trades on a P/E ratio of 16.0, which is fairly close to the NL market average of 15.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect Pharming Group to have a higher P/E ratio. All the more so, since analysts expect further profit growth. Click here to research this potential opportunity.. What can be absolutely certain is that the market has become significantly less optimistic about Pharming Group over the last month, with the P/E ratio falling from 24.1 back then to 16.0 today. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Pharming Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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