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How Does Electromed's (NYSEMKT:ELMD) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

It's really great to see that even after a strong run, Electromed (NYSEMKT:ELMD) shares have been powering on, with a gain of 47% in the last thirty days. Looking back a bit further, we're also happy to report the stock is up 59% 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.

Check out our latest analysis for Electromed

How Does Electromed's P/E Ratio Compare To Its Peers?

Electromed's P/E of 39.19 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Electromed has a lower P/E than the average (46.2) in the medical equipment industry classification.

AMEX:ELMD Price Estimation Relative to Market, November 14th 2019

Electromed's P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Electromed's earnings per share grew by -6.3% in the last twelve months. Unfortunately, earnings per share are down 4.5% a year, over 3 years.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Electromed's Balance Sheet

Since Electromed holds net cash of US$7.8m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Electromed's P/E Ratio

Electromed has a P/E of 39.2. That's higher than the average in its market, which is 18.2. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen! What is very clear is that the market has become significantly more optimistic about Electromed over the last month, with the P/E ratio rising from 26.7 back then to 39.2 today. 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.

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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Electromed 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.