Despite Its High P/E Ratio, Is Fisher & Paykel Healthcare Corporation Limited (NZSE:FPH) Still Undervalued?

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Fisher & Paykel Healthcare Corporation Limited’s (NZSE:FPH) P/E ratio to inform your assessment of the investment opportunity. What is Fisher & Paykel Healthcare’s P/E ratio? Well, based on the last twelve months it is 44.08. That corresponds to an earnings yield of approximately 2.3%.

Check out our latest analysis for Fisher & Paykel Healthcare

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Fisher & Paykel Healthcare:

P/E of 44.08 = NZ$15.91 ÷ NZ$0.36 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Fisher & Paykel Healthcare increased earnings per share by an impressive 19% over the last twelve months. And it has bolstered its earnings per share by 17% per year over the last five years. This could arguably justify a relatively high P/E ratio.

Does Fisher & Paykel Healthcare Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Fisher & Paykel Healthcare has a P/E ratio that is roughly in line with the medical equipment industry average (42.8).

NZSE:FPH Price Estimation Relative to Market, May 12th 2019
NZSE:FPH Price Estimation Relative to Market, May 12th 2019

That indicates that the market expects Fisher & Paykel Healthcare will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

Remember: P/E Ratios Don’t Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Fisher & Paykel Healthcare’s Debt Impact Its P/E Ratio?

Since Fisher & Paykel Healthcare holds net cash of NZ$15m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Fisher & Paykel Healthcare’s P/E Ratio

Fisher & Paykel Healthcare has a P/E of 44.1. That’s higher than the average in the NZ market, which is 18.1. With cash in the bank the company has plenty of growth options — and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.