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Despite Its High P/E Ratio, Is CRH Medical Corporation (TSE:CRH) Still Undervalued?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how CRH Medical Corporation's (TSE:CRH) P/E ratio could help you assess the value on offer. Based on the last twelve months, CRH Medical's P/E ratio is 56.03. That is equivalent to an earnings yield of about 1.8%.

See our latest analysis for CRH Medical

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for CRH Medical:

P/E of 56.03 = CA$3.29 (Note: this is the share price in the reporting currency, namely, USD ) ÷ CA$0.06 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does CRH Medical's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (40.3) for companies in the healthcare industry is lower than CRH Medical's P/E.

TSX:CRH Price Estimation Relative to Market, December 9th 2019
TSX:CRH Price Estimation Relative to Market, December 9th 2019

Its relatively high P/E ratio indicates that CRH Medical shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

CRH Medical shrunk earnings per share by 64% over the last year. But EPS is up 3.8% over the last 5 years. And over the longer term (3 years) earnings per share have decreased 17% annually. This growth rate might warrant a low P/E ratio.

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

The 'Price' in P/E reflects the market capitalization of the company. 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 CRH Medical's Debt Impact Its P/E Ratio?

CRH Medical's net debt equates to 28% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On CRH Medical's P/E Ratio

CRH Medical's P/E is 56.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With some debt but no EPS growth last year, the market has high expectations of future profits.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than CRH Medical. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.

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