Encompass Health Corporation's (NYSE:EHC) Price Is Out Of Tune With Earnings

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 23.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Encompass Health certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See 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?

The only time you'd be truly comfortable seeing a P/E as high as Encompass Health's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 21% gain to the company's bottom line. As a result, it also grew EPS by 27% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Turning to the outlook, the next three years should generate growth of 6.7% per year as estimated by the twelve analysts watching the company. With the market predicted to deliver 10% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Encompass Health's P/E sits above the majority of other companies. 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 1 warning sign for Encompass Health that you should be aware of.

Of course, you might also be able to find a better stock than Encompass Health. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.