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Do You Know What Cipher Pharmaceuticals Inc.'s (TSE:CPH) P/E Ratio Means?

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Simply Wall St
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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Cipher Pharmaceuticals Inc.'s (TSE:CPH) P/E ratio could help you assess the value on offer. Based on the last twelve months, Cipher Pharmaceuticals's P/E ratio is 9.23. That is equivalent to an earnings yield of about 11%.

See our latest analysis for Cipher Pharmaceuticals

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Cipher Pharmaceuticals:

P/E of 9.23 = $1.02 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.11 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Cipher Pharmaceuticals's earnings per share fell by 74% in the last twelve months. But EPS is up 40% over the last 3 years. And it has shrunk its earnings per share by 36% per year over the last five years. This growth rate might warrant a below average P/E ratio.

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

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Cipher Pharmaceuticals has a lower P/E than the average (19.3) P/E for companies in the pharmaceuticals industry.

TSX:CPH Price Estimation Relative to Market, July 8th 2019
TSX:CPH Price Estimation Relative to Market, July 8th 2019

Cipher Pharmaceuticals's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Cipher Pharmaceuticals, 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.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Cipher Pharmaceuticals's Balance Sheet Tell Us?

Cipher Pharmaceuticals's net debt equates to 28% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Cipher Pharmaceuticals's P/E Ratio

Cipher Pharmaceuticals has a P/E of 9.2. That's below the average in the CA market, which is 15.3. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Cipher Pharmaceuticals. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.