Eagle Health Holdings (ASX:EHH) shareholders are no doubt pleased to see that the share price has bounced 50% in the last month alone, although it is still down 45% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 36% 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Eagle Health Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 3.50 that sentiment around Eagle Health Holdings isn't particularly high. The image below shows that Eagle Health Holdings has a lower P/E than the average (20.9) P/E for companies in the personal products industry.
Its relatively low P/E ratio indicates that Eagle Health Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Eagle Health Holdings earnings growth of 23% in the last year.
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 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 Eagle Health Holdings's P/E?
Since Eagle Health Holdings holds net cash of AU$4.4m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Eagle Health Holdings's P/E Ratio
Eagle Health Holdings trades on a P/E ratio of 3.5, which is below the AU market average of 18.3. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What we know for sure is that investors are becoming less uncomfortable about Eagle Health Holdings's prospects, since they have pushed its P/E ratio from 2.3 to 3.5 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts you might want to assess this data-rich visualization 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.
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 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. Thank you for reading.