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A Rising Share Price Has Us Looking Closely At Medical Facilities Corporation's (TSE:DR) P/E Ratio

Simply Wall St

Medical Facilities (TSE:DR) shareholders are no doubt pleased to see that the share price has bounced 68% in the last month alone, although it is still down 20% over the last quarter. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 76% share price decline throughout the year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

View our latest analysis for Medical Facilities

Does Medical Facilities Have A Relatively High Or Low P/E For Its Industry?

Medical Facilities's P/E of 1.93 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Medical Facilities has a lower P/E than the average (27.7) in the healthcare industry classification.

TSX:DR Price Estimation Relative to Market April 17th 2020

This suggests that market participants think Medical Facilities will underperform other companies in its industry. Since the market seems unimpressed with Medical Facilities, 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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, Medical Facilities grew EPS like Taylor Swift grew her fan base back in 2010; the 94% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 18% is also impressive. So I'd be surprised if the P/E ratio was not above average.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Medical Facilities's Balance Sheet Tell Us?

Medical Facilities has net debt worth a very significant 140% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On Medical Facilities's P/E Ratio

Medical Facilities has a P/E of 1.9. That's below the average in the CA market, which is 11.5. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified. What we know for sure is that investors are becoming less uncomfortable about Medical Facilities's prospects, since they have pushed its P/E ratio from 1.1 to 1.9 over the last month. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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 modest (or no) debt, trading on a P/E below 20.

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.

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. Thank you for reading.