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How Does PRA Health Sciences's (NASDAQ:PRAH) P/E Compare To Its Industry, After The Share Price Drop?

Simply Wall St

Unfortunately for some shareholders, the PRA Health Sciences (NASDAQ:PRAH) share price has dived 38% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 37% drop over twelve months.

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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

See our latest analysis for PRA Health Sciences

How Does PRA Health Sciences's P/E Ratio Compare To Its Peers?

PRA Health Sciences's P/E of 18.30 indicates relatively low sentiment towards the stock. If you look at the image below, you can see PRA Health Sciences has a lower P/E than the average (27.8) in the life sciences industry classification.

NasdaqGS:PRAH Price Estimation Relative to Market, March 17th 2020

Its relatively low P/E ratio indicates that PRA Health Sciences shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with PRA Health Sciences, 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

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

PRA Health Sciences's 57% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 50% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

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.

Is Debt Impacting PRA Health Sciences's P/E?

Net debt totals 23% of PRA Health Sciences's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Bottom Line On PRA Health Sciences's P/E Ratio

PRA Health Sciences trades on a P/E ratio of 18.3, which is above its market average of 12.7. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What can be absolutely certain is that the market has become significantly less optimistic about PRA Health Sciences over the last month, with the P/E ratio falling from 29.5 back then to 18.3 today. 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.

Investors should be looking to buy stocks that the market is wrong about. 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: PRA Health Sciences 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).

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.

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. Thank you for reading.