Should You Be Tempted To Sell Eagle Pharmaceuticals, Inc. (NASDAQ:EGRX) Because Of Its P/E Ratio?

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll apply a basic P/E ratio analysis to Eagle Pharmaceuticals, Inc.’s (NASDAQ:EGRX), to help you decide if the stock is worth further research. Eagle Pharmaceuticals has a P/E ratio of 20.6, based on the last twelve months. That corresponds to an earnings yield of approximately 4.9%.

Check out our latest analysis for Eagle Pharmaceuticals

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Eagle Pharmaceuticals:

P/E of 20.6 = $54.2 ÷ $2.63 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Eagle Pharmaceuticals Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Eagle Pharmaceuticals has a P/E ratio that is fairly close for the average for the biotechs industry, which is 19.2.

NasdaqGM:EGRX Price Estimation Relative to Market, July 15th 2019
NasdaqGM:EGRX Price Estimation Relative to Market, July 15th 2019

That indicates that the market expects Eagle Pharmaceuticals will perform roughly in line with other companies in its industry.

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. 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.

Most would be impressed by Eagle Pharmaceuticals earnings growth of 25% in the last year.

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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Eagle Pharmaceuticals’s Balance Sheet Tell Us?

The extra options and safety that comes with Eagle Pharmaceuticals’s US$60m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Eagle Pharmaceuticals’s P/E Ratio

Eagle Pharmaceuticals has a P/E of 20.6. That’s higher than the average in its market, which is 18. With cash in the bank the company has plenty of growth options — and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Eagle Pharmaceuticals 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).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.