Earnings Not Telling The Story For Encompass Health Corporation (NYSE:EHC)

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Encompass Health Corporation (NYSE:EHC) as a stock to potentially avoid with its 22.6x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Encompass Health has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Encompass Health

Keen to find out how analysts think Encompass Health's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Encompass Health's Growth Trending?

In order to justify its P/E ratio, Encompass Health would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 21% last year. Pleasingly, EPS has also lifted 34% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 8.2% per year over the next three years. That's shaping up to be materially lower than the 11% per annum growth forecast for the broader market.

With this information, we find it concerning that Encompass Health is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Encompass Health currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Encompass Health has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on Encompass Health, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.