Does Estia Health Limited’s (ASX:EHE) P/E Ratio Signal A Buying Opportunity?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Estia Health Limited’s (ASX:EHE) P/E ratio to inform your assessment of the investment opportunity. What is Estia Health’s P/E ratio? Well, based on the last twelve months it is 18.44. That is equivalent to an earnings yield of about 5.4%.

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How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Estia Health:

P/E of 18.44 = A$2.97 ÷ A$0.16 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Estia Health’s earnings per share were pretty steady over the last year. But over the longer term (3 years), earnings per share have increased by 3.5%.

How Does Estia Health’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (18.5) for companies in the healthcare industry is roughly the same as Estia Health’s P/E.

ASX:EHE Price Estimation Relative to Market, May 18th 2019
ASX:EHE Price Estimation Relative to Market, May 18th 2019

That indicates that the market expects Estia Health will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

So What Does Estia Health’s Balance Sheet Tell Us?

Net debt totals just 8.5% of Estia Health’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Estia Health’s P/E Ratio

Estia Health’s P/E is 18.4 which is above average (16) in the AU market. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.

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. 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 Estia Health. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.