Biogen (NASDAQ:BIIB) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. The bad news is that even after that recovery shareholders are still underwater by about 5.3% for the full year.
Assuming no other changes, a sharply higher share price makes a stock less 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock 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.
How Does Biogen's P/E Ratio Compare To Its Peers?
Biogen's P/E of 10.67 indicates relatively low sentiment towards the stock. The image below shows that Biogen has a lower P/E than the average (16.3) P/E for companies in the biotechs industry.
This suggests that market participants think Biogen will underperform other companies in its industry. Since the market seems unimpressed with Biogen, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.
Biogen's earnings made like a rocket, taking off 83% last year. The sweetener is that the annual five year growth rate of 21% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
Biogen's Balance Sheet
Biogen's net debt is 2.8% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Biogen's P/E Ratio
Biogen's P/E is 10.7 which is below average (17.8) in the US market. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. What we know for sure is that investors have become more excited about Biogen recently, since they have pushed its P/E ratio from 8.1 to 10.7 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Biogen. So you may wish to see this free collection of other companies that have grown earnings strongly.
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