Why CRH Medical Corporation’s (TSE:CRH) High P/E Ratio Isn’t Necessarily A Bad Thing

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use CRH Medical Corporation’s (TSE:CRH) P/E ratio to inform your assessment of the investment opportunity. CRH Medical has a price to earnings ratio of 63, based on the last twelve months. In other words, at today’s prices, investors are paying CA$63 for every CA$1 in prior year profit.

See our latest analysis for CRH Medical

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for CRH Medical:

P/E of 63 = $3.09 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.049 (Based on the trailing twelve months 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 CA$1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Does CRH Medical’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that CRH Medical has a higher P/E than the average (57.6) P/E for companies in the healthcare industry.

TSX:CRH Price Estimation Relative to Market, September 2nd 2019
TSX:CRH Price Estimation Relative to Market, September 2nd 2019

That means that the market expects CRH Medical will outperform other companies in its industry.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

CRH Medical shrunk earnings per share by 74% over the last year. And over the longer term (3 years) earnings per share have decreased 17% annually. This could justify a low P/E.

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

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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).

So What Does CRH Medical’s Balance Sheet Tell Us?

CRH Medical’s net debt equates to 29% of its market capitalization. While that’s enough to warrant consideration, it doesn’t really concern us.

The Verdict On CRH Medical’s P/E Ratio

CRH Medical’s P/E is 63 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than CRH Medical. 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.