Even With A 26% Surge, Cautious Investors Are Not Rewarding Extendicare Inc.'s (TSE:EXE) Performance Completely

Despite an already strong run, Extendicare Inc. (TSE:EXE) shares have been powering on, with a gain of 26% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 81% in the last year.

In spite of the firm bounce in price, it's still not a stretch to say that Extendicare's price-to-earnings (or "P/E") ratio of 18.6x right now seems quite "middle-of-the-road" compared to the market in Canada, where the median P/E ratio is around 17x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

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Extendicare certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

See our latest analysis for Extendicare

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Is There Some Growth For Extendicare?

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

If we review the last year of earnings growth, the company posted a terrific increase of 40%. The strong recent performance means it was also able to grow EPS by 1,419% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Comparing that to the market, which is only predicted to deliver 22% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's curious that Extendicare's P/E sits in line with the majority of other companies. Apparently some shareholders believe the recent performance is at its limits and have been accepting lower selling prices.

The Final Word

Extendicare appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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.

Our examination of Extendicare revealed its three-year earnings trends aren't contributing to its P/E as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Extendicare, and understanding should be part of your investment process.

If you're unsure about the strength of Extendicare'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.