Abiomed (NASDAQ:ABMD) shares have had a really impressive month, gaining 32%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 30% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock 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 Abiomed's P/E Ratio Compare To Its Peers?
Abiomed's P/E of 35.25 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (45.4) for companies in the medical equipment industry is higher than Abiomed's P/E.
Its relatively low P/E ratio indicates that Abiomed shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Abiomed, it's quite possible it could surprise on the upside. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Abiomed saw earnings per share improve by 9.3% last year. And it has bolstered its earnings per share by 64% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Abiomed's P/E?
The extra options and safety that comes with Abiomed's US$428m 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 Abiomed's P/E Ratio
Abiomed trades on a P/E ratio of 35.3, which is above its market average of 14.9. Earnings improved over the last year. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come. What is very clear is that the market has become significantly more optimistic about Abiomed over the last month, with the P/E ratio rising from 26.6 back then to 35.3 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course you might be able to find a better stock than Abiomed. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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