To the annoyance of some shareholders, Stryker (NYSE:SYK) shares are down a considerable 35% in the last month. Even longer term holders have taken a real hit with the stock declining 27% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Stryker’s P/E Ratio Compare To Its Peers?
Stryker’s P/E of 25.82 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Stryker has a lower P/E than the average (32.7) in the medical equipment industry classification.
This suggests that market participants think Stryker will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Stryker’s earnings per share fell by 41% in the last twelve months. But it has grown its earnings per share by 33% per year over the last five years.
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. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Stryker’s Debt Impact Its P/E Ratio?
Net debt totals 12% of Stryker’s 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 Stryker’s P/E Ratio
Stryker has a P/E of 25.8. That’s higher than the average in its market, which is 12.7. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years. What can be absolutely certain is that the market has become significantly less optimistic about Stryker over the last month, with the P/E ratio falling from 39.8 back then to 25.8 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. If the reality for a company is better than it expects, you can make money by buying and holding for the long term.
