To the annoyance of some shareholders, EuroEyes International Eye Clinic (HKG:1846) shares are down a considerable 34% in the last month. The bad news is that the recent drop obliterated the last year's worth of gains; the stock is flat over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more 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, 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 EuroEyes International Eye Clinic's P/E Ratio Compare To Its Peers?
EuroEyes International Eye Clinic's P/E of 59.31 indicates some degree of optimism towards the stock. The image below shows that EuroEyes International Eye Clinic has a significantly higher P/E than the average (14.5) P/E for companies in the healthcare industry.
Its relatively high P/E ratio indicates that EuroEyes International Eye Clinic shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
EuroEyes International Eye Clinic's earnings per share fell by 66% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 1.5%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does EuroEyes International Eye Clinic's Balance Sheet Tell Us?
The extra options and safety that comes with EuroEyes International Eye Clinic's €17m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On EuroEyes International Eye Clinic's P/E Ratio
With a P/E ratio of 59.3, EuroEyes International Eye Clinic is expected to grow earnings very strongly in the years to come. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! What can be absolutely certain is that the market has become significantly less optimistic about EuroEyes International Eye Clinic over the last month, with the P/E ratio falling from 90.4 back then to 59.3 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: EuroEyes International Eye Clinic 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 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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