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A Rising Share Price Has Us Looking Closely At Vita Life Sciences Limited's (ASX:VLS) P/E Ratio

Simply Wall St

The Vita Life Sciences (ASX:VLS) share price has done well in the last month, posting a gain of 31%. But shareholders may not all be feeling jubilant, since the share price is still down 14% 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). 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.

Check out our latest analysis for Vita Life Sciences

How Does Vita Life Sciences's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 29.09 that sentiment around Vita Life Sciences isn't particularly high. The image below shows that Vita Life Sciences has a lower P/E than the average (40.2) P/E for companies in the pharmaceuticals industry.

ASX:VLS Price Estimation Relative to Market, January 15th 2020

This suggests that market participants think Vita Life Sciences will underperform other companies in its industry. Since the market seems unimpressed with Vita Life Sciences, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Vita Life Sciences saw earnings per share decrease by 61% last year. And over the longer term (5 years) earnings per share have decreased 27% annually. This could justify a pessimistic P/E.

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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

Vita Life Sciences's Balance Sheet

Vita Life Sciences has net cash of AU$7.5m. This is fairly high at 17% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Vita Life Sciences's P/E Ratio

Vita Life Sciences's P/E is 29.1 which is above average (18.9) in its market. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What is very clear is that the market has become significantly more optimistic about Vita Life Sciences over the last month, with the P/E ratio rising from 22.2 back then to 29.1 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph 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.

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.