It’s great to see Metropolis Healthcare (NSE:METROPOLIS) shareholders have their patience rewarded with a 31% share price pop in the last month. Longer term shareholders are no doubt thankful for the recovery in the share price, since it’s pretty much flat for the year, even after the recent pop.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Metropolis Healthcare’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 62.84 that there is some investor optimism about Metropolis Healthcare. As you can see below, Metropolis Healthcare has a higher P/E than the average company (22.6) in the healthcare industry.
That means that the market expects Metropolis Healthcare will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Metropolis Healthcare grew EPS by 20% in the last year. And earnings per share have improved by 18% annually, over the last five years. So one might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Metropolis Healthcare’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Metropolis Healthcare’s ₹1.6b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Metropolis Healthcare’s P/E Ratio
Metropolis Healthcare’s P/E is 62.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average. What is very clear is that the market has become significantly more optimistic about Metropolis Healthcare over the last month, with the P/E ratio rising from 48.0 back then to 62.8 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is ‘blood in the streets’, then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Metropolis Healthcare. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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