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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use UnitedHealth Group Incorporated's (NYSE:UNH) P/E ratio to inform your assessment of the investment opportunity. UnitedHealth Group has a P/E ratio of 18.33, based on the last twelve months. That means that at current prices, buyers pay $18.33 for every $1 in trailing yearly profits.
How Do I Calculate UnitedHealth Group's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for UnitedHealth Group:
P/E of 18.33 = $240.59 ÷ $13.13 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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 UnitedHealth Group earnings growth of 13% in the last year. And it has bolstered its earnings per share by 19% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does UnitedHealth Group's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (20.7) for companies in the healthcare industry is higher than UnitedHealth Group's P/E.
This suggests that market participants think UnitedHealth Group will underperform other companies in its industry. Since the market seems unimpressed with UnitedHealth Group, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting UnitedHealth Group's P/E?
UnitedHealth Group's net debt is 9.9% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On UnitedHealth Group's P/E Ratio
UnitedHealth Group trades on a P/E ratio of 18.3, which is fairly close to the US market average of 18. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 UnitedHealth Group. 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 email@example.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.