Those holding NuVasive (NASDAQ:NUVA) shares must be pleased that the share price has rebounded 35% in the last thirty days. But unfortunately, the stock is still down by 28% over a quarter. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
Does NuVasive Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 46.54 that there is some investor optimism about NuVasive. You can see in the image below that the average P/E (41.5) for companies in the medical equipment industry is lower than NuVasive's P/E.
Its relatively high P/E ratio indicates that NuVasive 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 delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
NuVasive's earnings made like a rocket, taking off 417% last year. Even better, EPS is up 19% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. 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.
NuVasive's Balance Sheet
NuVasive has net debt worth 13% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On NuVasive's P/E Ratio
NuVasive's P/E is 46.5 which is way above average (14.0) in its market. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What is very clear is that the market has become significantly more optimistic about NuVasive over the last month, with the P/E ratio rising from 34.6 back then to 46.5 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.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 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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