The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Metlifecare Limited's (NZSE:MET), to help you decide if the stock is worth further research. Metlifecare has a P/E ratio of 25.22, based on the last twelve months. That is equivalent to an earnings yield of about 4.0%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Metlifecare:
P/E of 25.22 = NZ$4.65 ÷ NZ$0.18 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each NZ$1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Metlifecare's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (16.2) for companies in the healthcare industry is lower than Metlifecare's P/E.
That means that the market expects Metlifecare will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Metlifecare shrunk earnings per share by 68% over the last year. And over the longer term (5 years) earnings per share have decreased 11% annually. This could justify a pessimistic P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Metlifecare's Balance Sheet Tell Us?
Metlifecare's net debt equates to 28% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Metlifecare's P/E Ratio
Metlifecare trades on a P/E ratio of 25.2, which is above its market average of 18.4. 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 Metlifecare. 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).
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.