To the annoyance of some shareholders, Medpace Holdings (NASDAQ:MEDP) shares are down a considerable 33% in the last month. The stock has been solid, longer term, gaining 17% in the last year.
All else being equal, a share price drop should make a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Medpace Holdings's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 24.35 that sentiment around Medpace Holdings isn't particularly high. The image below shows that Medpace Holdings has a lower P/E than the average (28.2) P/E for companies in the life sciences industry.
Its relatively low P/E ratio indicates that Medpace Holdings shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Medpace Holdings grew EPS by a whopping 36% in the last year. And earnings per share have improved by 95% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio.
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. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Medpace Holdings's Balance Sheet Tell Us?
Since Medpace Holdings holds net cash of US$132m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Medpace Holdings's P/E Ratio
Medpace Holdings trades on a P/E ratio of 24.3, which is above its market average of 12.6. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Medpace Holdings to have a high P/E ratio. Given Medpace Holdings's P/E ratio has declined from 36.5 to 24.3 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course you might be able to find a better stock than Medpace Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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