With a price-to-earnings (or "P/E") ratio of 43x HealthStream, Inc. (NASDAQ:HSTM) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
HealthStream certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
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Does Growth Match The High P/E?
In order to justify its P/E ratio, HealthStream would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a decent 15% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 309% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the six analysts covering the company are not good at all, suggesting earnings should decline by 56% over the next year. The market is also set to see earnings decline 9.0% but the stock is shaping up to perform materially worse.
With this information, it's strange that HealthStream is trading at a higher P/E in comparison. When earnings shrink rapidly often the P/E premium shrinks too, which could set up shareholders for future disappointment. There's strong potential for the P/E to fall to lower levels if the company doesn't improve its profitability.
The Bottom Line On HealthStream's P/E
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that HealthStream currently trades on a much higher than expected P/E since its earnings forecast is even worse than the struggling market. When we see a weak earnings outlook, we suspect the share price is at risk of declining, sending the high P/E lower. We're also cautious about the company's ability to resist even greater pain to its business from the broader market turmoil. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
You always need to take note of risks, for example - HealthStream has 1 warning sign we think you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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