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A Sliding Share Price Has Us Looking At NMC Health Plc's (LON:NMC) P/E Ratio

·4 min read

To the annoyance of some shareholders, NMC Health (LON:NMC) shares are down a considerable 48% in the last month. And that drop will have no doubt have some shareholders concerned that the 73% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.

All else being equal, a share price drop should make a stock more attractive to potential investors. 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for NMC Health

Does NMC Health Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 6.96 that sentiment around NMC Health isn't particularly high. If you look at the image below, you can see NMC Health has a lower P/E than the average (22.2) in the healthcare industry classification.

LSE:NMC Price Estimation Relative to Market, February 9th 2020
LSE:NMC Price Estimation Relative to Market, February 9th 2020

This suggests that market participants think NMC Health will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

It's great to see that NMC Health grew EPS by 24% in the last year. And earnings per share have improved by 26% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

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.

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.

NMC Health's Balance Sheet

NMC Health's net debt is 81% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Verdict On NMC Health's P/E Ratio

NMC Health trades on a P/E ratio of 7.0, which is below the GB market average of 18.0. The company may have significant debt, but EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given NMC Health's P/E ratio has declined from 13.3 to 7.0 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than NMC Health. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.