Dedicare (STO:DEDI) shareholders are no doubt pleased to see that the share price has had a great month, posting a 32% gain, recovering from prior weakness. But that gain wasn't enough to make shareholders whole, as the share price is still down 8.8% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does Dedicare Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 17.00 that sentiment around Dedicare isn't particularly high. If you look at the image below, you can see Dedicare has a lower P/E than the average (18.9) in the healthcare industry classification.
This suggests that market participants think Dedicare will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Dedicare's earnings per share fell by 35% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 9.9%. And EPS is down 14% a year, over the last 3 years. This could justify a low P/E.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Dedicare's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Dedicare's kr32m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Dedicare's P/E Ratio
Dedicare trades on a P/E ratio of 17.0, which is below the SE market average of 19.4. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What we know for sure is that investors have become more excited about Dedicare recently, since they have pushed its P/E ratio from 12.9 to 17.0 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Dedicare 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 firstname.lastname@example.org. 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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