Is Ramsay Health Care Limited’s (ASX:RHC) High P/E Ratio A Problem For Investors?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Ramsay Health Care Limited’s (ASX:RHC) P/E ratio and reflect on what it tells us about the company’s share price. What is Ramsay Health Care’s P/E ratio? Well, based on the last twelve months it is 34.92. That corresponds to an earnings yield of approximately 2.9%.

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How Do You Calculate Ramsay Health Care’s P/E Ratio?

The formula for price to earnings is:

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

Or for Ramsay Health Care:

P/E of 34.92 = A$69.31 ÷ A$1.99 (Based on the trailing twelve months to December 2018.)

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. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

Ramsay Health Care shrunk earnings per share by 14% over the last year. But over the longer term (5 years) earnings per share have increased by 8.0%.

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

The P/E ratio essentially measures market expectations of a company. The image below shows that Ramsay Health Care has a higher P/E than the average (18.3) P/E for companies in the healthcare industry.

ASX:RHC Price Estimation Relative to Market, May 22nd 2019
ASX:RHC Price Estimation Relative to Market, May 22nd 2019

Its relatively high P/E ratio indicates that Ramsay Health Care shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 Ramsay Health Care’s Debt Impact Its P/E Ratio?

Net debt is 39% of Ramsay Health Care’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.

The Bottom Line On Ramsay Health Care’s P/E Ratio

Ramsay Health Care has a P/E of 34.9. That’s higher than the average in the AU market, which is 16. 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.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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.

You might be able to find a better buy than Ramsay Health Care. 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).

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.