It's really great to see that even after a strong run, Molina Healthcare (NYSE:MOH) shares have been powering on, with a gain of 31% in the last thirty days. The full year gain of 33% is pretty reasonable, too.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Molina Healthcare's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 14.91 that sentiment around Molina Healthcare isn't particularly high. If you look at the image below, you can see Molina Healthcare has a lower P/E than the average (20.6) in the healthcare industry classification.
This suggests that market participants think Molina Healthcare will underperform other companies in its industry. Since the market seems unimpressed with Molina Healthcare, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Molina Healthcare shrunk earnings per share by 10% over the last year. But it has grown its earnings per share by 45% per year over the last five years.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Molina Healthcare's Debt Impact Its P/E Ratio?
Molina Healthcare has net cash of US$2.8b. This is fairly high at 27% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Molina Healthcare's P/E Ratio
Molina Healthcare trades on a P/E ratio of 14.9, which is fairly close to the US market average of 14.4. Although the recent drop in earnings per share would keep the market cautious, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E. What is very clear is that the market has become more optimistic about Molina Healthcare over the last month, with the P/E ratio rising from 11.4 back then to 14.9 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Molina Healthcare. So you may wish to see this free collection of other companies that have grown earnings strongly.
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