BBI Life Sciences (HKG:1035) shareholders are no doubt pleased to see that the share price has had a great month, posting a 39% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 11% 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does BBI Life Sciences's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 14.21 that sentiment around BBI Life Sciences isn't particularly high. We can see in the image below that the average P/E (49.9) for companies in the life sciences industry is higher than BBI Life Sciences's P/E.
Its relatively low P/E ratio indicates that BBI Life Sciences shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You 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. 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.
BBI Life Sciences increased earnings per share by an impressive 21% over the last twelve months. And its annual EPS growth rate over 3 years is 14%. This could arguably justify a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does BBI Life Sciences's Debt Impact Its P/E Ratio?
The extra options and safety that comes with BBI Life Sciences's CN¥81m 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 BBI Life Sciences's P/E Ratio
BBI Life Sciences has a P/E of 14.2. That's higher than the average in its market, which is 10.4. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio. What is very clear is that the market has become more optimistic about BBI Life Sciences over the last month, with the P/E ratio rising from 10.2 back then to 14.2 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than BBI Life Sciences. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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. Thank you for reading.