Amedisys (NASDAQ:AMED) shares have had a really impressive month, gaining 45%, after some slippage. Looking back a bit further, we're also happy to report the stock is up 72% 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. One way to gauge market expectations of a stock 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 Amedisys Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 50.41 that there is some investor optimism about Amedisys. You can see in the image below that the average P/E (21.7) for companies in the healthcare industry is lower than Amedisys's P/E.
That means that the market expects Amedisys will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Amedisys saw earnings per share improve by 8.4% last year. And its annual EPS growth rate over 5 years is 58%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Amedisys's P/E?
Amedisys has net debt worth just 3.2% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Amedisys's P/E Ratio
Amedisys's P/E is 50.4 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement. What is very clear is that the market has become significantly more optimistic about Amedisys over the last month, with the P/E ratio rising from 34.8 back then to 50.4 today. 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Amedisys. 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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