To the annoyance of some shareholders, NuVasive (NASDAQ:NUVA) shares are down a considerable 47% in the last month. The recent drop has obliterated the annual return, with the share price now down 30% over that longer period.
All else being equal, a share price drop should make a stock more 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 long term investors have an opportunity when expectations of a company are too low. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does NuVasive Have A Relatively High Or Low P/E For Its Industry?
NuVasive's P/E is 32.00. You can see in the image below that the average P/E (31.6) for companies in the medical equipment industry is roughly the same as NuVasive's P/E.
NuVasive's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, NuVasive grew EPS like Taylor Swift grew her fan base back in 2010; the 417% gain was both fast and well deserved. And earnings per share have improved by 19% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
NuVasive's Balance Sheet
NuVasive's net debt is 20% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On NuVasive's P/E Ratio
NuVasive's P/E is 32.0 which is above average (11.5) 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 can be absolutely certain is that the market has become significantly less optimistic about NuVasive over the last month, with the P/E ratio falling from 59.9 back then to 32.0 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 be able to find a better stock than NuVasive. 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 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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