When close to half the companies in Singapore have price-to-earnings ratios (or "P/E's") below 10x, you may consider OUE Lippo Healthcare Limited (Catalist:5WA) as a stock to avoid entirely with its 22.5x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
As an illustration, earnings have deteriorated at OUE Lippo Healthcare over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
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Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like OUE Lippo Healthcare's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 64%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Comparing that to the market, which is predicted to shrink 1.0% in the next 12 months, the company's positive momentum based on recent medium-term earnings results is a bright spot for the moment.
With this information, we can see why OUE Lippo Healthcare is trading at a high P/E compared to the market. Investors are willing to pay more for a stock they hope will buck the trend of the broader market going backwards. Nonetheless, with most other businesses facing an uphill battle, staying on its current earnings path is no certainty.
The Key Takeaway
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.
We've established that OUE Lippo Healthcare maintains its high P/E on the strength of its recentthree-year growth beating forecasts for a struggling market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. We still remain cautious about the company's ability to stay its recent course and swim against the current of the broader market turmoil. Otherwise, it's hard to see the share price falling strongly in the near future if its earnings performance persists.