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A Rising Share Price Has Us Looking Closely At Integral Diagnostics Limited's (ASX:IDX) P/E Ratio

Simply Wall St

Those holding Integral Diagnostics (ASX:IDX) shares must be pleased that the share price has rebounded 33% in the last thirty days. But unfortunately, the stock is still down by 22% over a quarter. Unfortunately, the full year gain of 5.6% wasn't so sweet.

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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.

See our latest analysis for Integral Diagnostics

How Does Integral Diagnostics's P/E Ratio Compare To Its Peers?

Integral Diagnostics's P/E of 25.26 indicates some degree of optimism towards the stock. The image below shows that Integral Diagnostics has a higher P/E than the average (14.3) P/E for companies in the healthcare industry.

ASX:IDX Price Estimation Relative to Market May 4th 2020

Its relatively high P/E ratio indicates that Integral Diagnostics shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Integral Diagnostics increased earnings per share by 8.8% last year. And earnings per share have improved by 27% annually, over the last five years.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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).

So What Does Integral Diagnostics's Balance Sheet Tell Us?

Integral Diagnostics has net debt worth 18% 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 Integral Diagnostics's P/E Ratio

Integral Diagnostics's P/E is 25.3 which is above average (14.6) in its market. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement. What is very clear is that the market has become significantly more optimistic about Integral Diagnostics over the last month, with the P/E ratio rising from 18.9 back then to 25.3 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.

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. 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 Integral Diagnostics. 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 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.

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. Thank you for reading.