Medibank Private Limited's (ASX:MPL) Prospects Need A Boost To Lift Shares

Medibank Private Limited's (ASX:MPL) price-to-earnings (or "P/E") ratio of 15.2x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 20x and even P/E's above 38x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been pleasing for Medibank Private as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for Medibank Private

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Medibank Private.

What Are Growth Metrics Telling Us About The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Medibank Private's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 102%. Pleasingly, EPS has also lifted 89% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 4.0% each year as estimated by the eleven analysts watching the company. That's not great when the rest of the market is expected to grow by 17% per annum.

In light of this, it's understandable that Medibank Private's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Medibank Private maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

You need to take note of risks, for example - Medibank Private has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

You might be able to find a better investment than Medibank Private. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.