Is Morneau Shepell Inc's (TSE:MSI) PE Ratio A Signal To Sell For Investors?

MSI's current PE is a sizable 37.07x based on past earnings, considerably outstripping the 20.16x average multiple of the CA Professional Services. But should this larger multiple be the final verdict of MSI’s overvaluation? No. This is because multiples like PE tend to overlook key company-specific factors such as future growth and capital structure. Below, I will lay out some important considerations to help determine which multiple best suits the fast-growing company, MSI. Let's dive in.

Is MSI making any money?

PE is only used when a company is profitable, such as MSI. This is because the multiple is not applicable to companies that are not generating positive earnings. Companies like this are often valued based off other relevant factors, using multiples like P/S (price-to-sales) or P/FCF (price-to-free-cash-flow) depending on the business characteristics. In the past, MSI has always maintained its profitability. This means an earnings-based multiple such as the PE ratio can be a useful valuation instrument, however, there may be a better option.

Does MSI owe a lot of money?

Yes. As a rule of thumb, debt shouldn’t exceed 40% of equity. Currently, ’s 74.47% debt-to-equity ratio indicates its financial positioning is not optimal. This ratio indicates that for every CA$1 you invest, the company owes CA$0.74 to debtors. This means that if the company were to go bankrupt, equity investors have a lower claim on assets than debt providers that is owed the lion’s share of assets.

So, what does debt have to do with valuation? The company’s share price theoretically reflects the value of MSI’s equity only, but its important to account for debt, because debt represents a liability to the owner, and it impacts the earnings capacity and risk profile of the company. The EV/EBITDA multiple, which uses EV as a substitute for share price, allows us to incorporate debt into our valuation. Comparing MSI’s multiple to the 16.58x for the industry suggests the company is overvalued, but not as much as the price-to-earnings ratio implied.

Will MSI experience high growth?

Yes. If analyst predictions are right, the company’s earnings are forecasted to grow by 22.38% every year for the next 5 years. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected growth, which isn’t ideal as you are using past values to gauge future performance. You should pay for what you’re going to get, not what’s already happened. To shift our analysis to focus on the future, we will use a forward figure for EBITDA based off analyst forecasts for the year ahead.

MSI’s multiple is within reasonable range of the industry’s 12.23x. This implies a fair valuation on a forward basis, in contrast to the trailing enterprise-value-to-EBITDA multiple which suggested the company was selling at a premium to fair value.

Next Steps:

Looking at relative valuation alone does not give you a complete picture of an investment. There are many important factors I have not taken into account in this article. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for ’s future growth? Take a look at our free research report of analyst consensus for ’s outlook.
2. Past Track Record: Has been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of 's historicals for more clarity.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.