How Does Estia Health's (ASX:EHE) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, Estia Health (ASX:EHE) shares are down a considerable 36% in the last month. That drop has capped off a tough year for shareholders, with the share price down 34% in that time.

All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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.

View our latest analysis for Estia Health

Does Estia Health Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 11.48 that sentiment around Estia Health isn't particularly high. We can see in the image below that the average P/E (16.8) for companies in the healthcare industry is higher than Estia Health's P/E.

Estia Health's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

When earnings fall, the 'E' decreases, over time. 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.

Estia Health saw earnings per share decrease by 18% last year. And it has shrunk its earnings per share by 6.5% per year over the last three years. This growth rate might warrant a low 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. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting Estia Health's P/E?

Net debt totals 22% of Estia Health'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 Bottom Line On Estia Health's P/E Ratio

Estia Health trades on a P/E ratio of 11.5, which is below the AU market average of 17.0. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth. Given Estia Health's P/E ratio has declined from 17.8 to 11.5 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Estia Health. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.