In This Article:
Ramsay Health Care Limited (ASX:RHC) trades with a trailing P/E of 26.9x, which is higher than the industry average of 21.1x. While this makes RHC appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Ramsay Health Care
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for RHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
RHC Price-Earnings Ratio = A$62.32 ÷ A$2.319 = 26.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as RHC, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. RHC’s P/E of 26.9x is higher than its industry peers (21.1x), which implies that each dollar of RHC’s earnings is being overvalued by investors. As such, our analysis shows that RHC represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your RHC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to RHC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with RHC, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing RHC to are fairly valued by the market. If this does not hold true, RHC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.