Medibank Private Limited (ASX:MPL) Investors Are Less Pessimistic Than Expected

It's not a stretch to say that Medibank Private Limited's (ASX:MPL) price-to-earnings (or "P/E") ratio of 20.7x right now seems quite "middle-of-the-road" compared to the market in Australia, where the median P/E ratio is around 19x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Medibank Private certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Medibank Private's is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a terrific increase of 30%. The strong recent performance means it was also able to grow EPS by 62% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 4.8% per annum as estimated by the eleven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 17% per annum, which is noticeably more attractive.

In light of this, it's curious that Medibank Private's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Bottom Line On Medibank Private's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Medibank Private's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Medibank Private that you should be aware of.

If you're unsure about the strength of Medibank Private's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.