Those holding FONAR (NASDAQ:FONR) shares must be pleased that the share price has rebounded 30% in the last thirty days. But unfortunately, the stock is still down by 8.6% over a quarter. The bad news is that even after that recovery shareholders are still underwater by about 2.0% for the full year.
All else being equal, a sharp share price increase should make a stock less 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. 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does FONAR Have A Relatively High Or Low P/E For Its Industry?
FONAR’s P/E of 9.19 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (44.4) for companies in the medical equipment industry is higher than FONAR’s P/E.
Its relatively low P/E ratio indicates that FONAR 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
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
FONAR shrunk earnings per share by 27% over the last year. But it has grown its earnings per share by 4.7% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 6.4% annually. This could justify a low P/E.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Is Debt Impacting FONAR’s P/E?
FONAR has net cash of US$30m. This is fairly high at 24% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On FONAR’s P/E Ratio
FONAR’s P/E is 9.2 which is below average (14.4) in the US market. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary. What is very clear is that the market has become less pessimistic about FONAR over the last month, with the P/E ratio rising from 7.1 back then to 9.2 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you’re more sensitive to price, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. Although we don’t have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than FONAR. 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 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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