To the annoyance of some shareholders, Fusen Pharmaceutical (HKG:1652) shares are down a considerable 31% in the last month. Looking at the bigger picture, the stock is up 70% in the last year.
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. 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.
How Does Fusen Pharmaceutical's P/E Ratio Compare To Its Peers?
Fusen Pharmaceutical's P/E of 39.60 indicates some degree of optimism towards the stock. The image below shows that Fusen Pharmaceutical has a significantly higher P/E than the average (11.6) P/E for companies in the pharmaceuticals industry.
That means that the market expects Fusen Pharmaceutical will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Fusen Pharmaceutical saw earnings per share decrease by 45% last year. But over the longer term (5 years) earnings per share have increased by 3.9%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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.
Is Debt Impacting Fusen Pharmaceutical's P/E?
Fusen Pharmaceutical has net cash of CN¥151m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Fusen Pharmaceutical's P/E Ratio
Fusen Pharmaceutical's P/E is 39.6 which is way above average (10.2) in its market. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. Given Fusen Pharmaceutical's P/E ratio has declined from 57.6 to 39.6 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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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