Ortin Laboratories (NSE:ORTINLAABS) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month alone, although it is still down 15% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 30% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
View our latest analysis for Ortin Laboratories
Does Ortin Laboratories Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 25.08 that there is some investor optimism about Ortin Laboratories. The image below shows that Ortin Laboratories has a higher P/E than the average (16.3) P/E for companies in the pharmaceuticals industry.
Its relatively high P/E ratio indicates that Ortin Laboratories shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Ortin Laboratories shrunk earnings per share by 38% over the last year. And over the longer term (5 years) earnings per share have decreased 8.3% annually. This could justify a pessimistic P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).