Why is there a perceived overvaluation of Smith & Nephew’s P/E ratio?
Price-to-earning ratio reflects the market’s expectations about a company’s performance and measures how much investors are willing to spend for a share relative to the company’s earnings. It can be computed by using the formula below:
P/E= Market Price per Share / Earnings per Share
In the analysis done by the other group, they seem to hastily conclude that Smith & Nephew is an overvalued company simply based on the fact that the EPS of Smith & Nephew has remained stagnant in the last four years, while Hikma is trending in the opposite direction upwards.
Our group, however, feels differently on this perceived overvaluation. In fact, there are several reasons that Smith & Nephew’s P/E has been climbing. Firstly, by looking at the numerator of this equation, we can see that their stock price has risen over
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As shown by the contradiction between share price growth and net profit decline, investor confidence in future returns is already high.
Moreover, P/E ratio is usually very high for high-growth companies. Therefore, using only the P/E ratio to evaluate a company's performance may easily give a wrong impression of overvaluation in high-growth companies.
Other important factors like the company’s long-term strategic vision should also be considered, as well, in their market valuation. Smith & Nephew’s three important acquisitions since 2012, namely Kalypto Medical, Arthrocare and Blue Belt Technologies, have only strengthened their market positioning even further, especially in the emerging markets. In addition, their expected growth in earnings for 2017 is 80%. These positive indicators only increase the confidence of the shareholders in the company's