Here’s How P/E Ratios Can Help Us Understand Japara Healthcare Limited (ASX:JHC)

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Japara Healthcare Limited’s (ASX:JHC) P/E ratio could help you assess the value on offer. What is Japara Healthcare’s P/E ratio? Well, based on the last twelve months it is 19.15. That corresponds to an earnings yield of approximately 5.2%.

View our latest analysis for Japara Healthcare

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Japara Healthcare:

P/E of 19.15 = A$1.18 ÷ A$0.06 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

How Does Japara Healthcare’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (19.2) for companies in the healthcare industry is roughly the same as Japara Healthcare’s P/E.

ASX:JHC Price Estimation Relative to Market, October 22nd 2019
ASX:JHC Price Estimation Relative to Market, October 22nd 2019

Its P/E ratio suggests that Japara Healthcare shareholders think that in the future it will perform about the same as other companies in its industry classification.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

Japara Healthcare shrunk earnings per share by 30% over the last year. And it has shrunk its earnings per share by 19% per year over the last three years. This growth rate might warrant a low P/E ratio. The company could impress by growing EPS, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).

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).

Is Debt Impacting Japara Healthcare’s P/E?

Net debt totals 59% of Japara Healthcare’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Bottom Line On Japara Healthcare’s P/E Ratio

Japara Healthcare trades on a P/E ratio of 19.2, which is fairly close to the AU market average of 18.4. With meaningful debt, and no earnings per share growth last year, even an average P/E indicates that the market a significant improvement from the business.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Japara Healthcare. 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.