Medifast (NYSE:MED) shares have had a really impressive month, gaining 31%, after some slippage. But that gain wasn’t enough to make shareholders whole, as the share price is still down 8.6% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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 deep value investors might steer clear when expectations of a company are too high. 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 Medifast’s P/E Ratio Compare To Its Peers?
Medifast’s P/E is 17.91. You can see in the image below that the average P/E (17.8) for companies in the personal products industry is roughly the same as Medifast’s P/E.
Medifast’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. 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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Medifast grew EPS like Taylor Swift grew her fan base back in 2010; the 58% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 25% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
How Does Medifast’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Medifast’s US$97m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Medifast’s P/E Ratio
Medifast has a P/E of 17.9. That’s around the same as the average in the US market, which is 18.9. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect Medifast to have a higher P/E ratio. What we know for sure is that investors have become more excited about Medifast recently, since they have pushed its P/E ratio from 13.7 to 17.9 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.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Medifast. 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 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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