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Morepen Laboratories (NSE:MOREPENLAB) shares have had a really impressive month, gaining 37%, after some slippage. But that gain wasn't enough to make shareholders whole, as the share price is still down 7.4% 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.
Check out our latest analysis for Morepen Laboratories
Does Morepen Laboratories Have A Relatively High Or Low P/E For Its Industry?
Morepen Laboratories's P/E of 28.13 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (16.3) for companies in the pharmaceuticals industry is lower than Morepen Laboratories's P/E.
That means that the market expects Morepen Laboratories will outperform other companies in its industry. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by Morepen Laboratories earnings growth of 17% in the last year. And it has improved its earnings per share by 40% per year over the last three years. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.