Unfortunately for some shareholders, the Charles River Laboratories International (NYSE:CRL) share price has dived 41% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 28% in the last year.
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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock 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.
Does Charles River Laboratories International Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 20.24 that sentiment around Charles River Laboratories International isn’t particularly high. We can see in the image below that the average P/E (27.8) for companies in the life sciences industry is higher than Charles River Laboratories International’s P/E.
Its relatively low P/E ratio indicates that Charles River Laboratories International 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. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
It’s great to see that Charles River Laboratories International grew EPS by 11% in the last year. And its annual EPS growth rate over 5 years is 13%. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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 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.
So What Does Charles River Laboratories International’s Balance Sheet Tell Us?
Charles River Laboratories International has net debt equal to 32% of its market cap. While that’s enough to warrant consideration, it doesn’t really concern us.
The Bottom Line On Charles River Laboratories International’s P/E Ratio
Charles River Laboratories International’s P/E is 20.2 which is above average (12.7) in its market. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. So on this analysis it seems reasonable that its P/E ratio is above average. What can be absolutely certain is that the market has become significantly less optimistic about Charles River Laboratories International over the last month, with the P/E ratio falling from 34.1 back then to 20.2 today. For those who don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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.
But note: Charles River Laboratories International may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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