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Despite Its High P/E Ratio, Is Metropolis Healthcare Limited (NSE:METROPOLIS) Still Undervalued?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Metropolis Healthcare Limited's (NSE:METROPOLIS) P/E ratio to inform your assessment of the investment opportunity. Metropolis Healthcare has a P/E ratio of 42.67, based on the last twelve months. That is equivalent to an earnings yield of about 2.3%.

See our latest analysis for Metropolis Healthcare

How Do You Calculate Metropolis Healthcare's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Metropolis Healthcare:

P/E of 42.67 = ₹1026.7 ÷ ₹24.06 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Metropolis Healthcare Have A Relatively High Or Low P/E For Its Industry?

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 (22.5) for companies in the healthcare industry is lower than Metropolis Healthcare's P/E.

NSEI:METROPOLIS Price Estimation Relative to Market, August 6th 2019

Its relatively high P/E ratio indicates that Metropolis Healthcare shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Most would be impressed by Metropolis Healthcare earnings growth of 15% in the last year. And earnings per share have improved by 17% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Metropolis Healthcare's Balance Sheet Tell Us?

Metropolis Healthcare has net cash of ₹765m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Metropolis Healthcare's P/E Ratio

Metropolis Healthcare trades on a P/E ratio of 42.7, which is multiples above its market average of 13.6. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Metropolis Healthcare may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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 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. Thank you for reading.