Is It Time To Buy HCA Healthcare Inc (HCA) Based Off Its PE Ratio?
HCA Healthcare Inc (NYSE:HCA) is trading with a trailing P/E of 10.2x, which is lower than the industry average of 21.7x. While this makes HCA appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for HCA Healthcare
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for HCA
Price per share = 78.22
Earnings per share = 7.674
∴ Price-Earnings Ratio = 78.22 ÷ 7.674 = 10.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to HCA, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
Since HCA's P/E of 10.2x is lower than its industry peers (21.7x), it means that investors are paying less than they should for each dollar of HCA's earnings. Therefore, according to this analysis, HCA is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy HCA immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to HCA. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with HCA, then HCA’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with HCA, HCA’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing HCA to are fairly valued by the market. If this does not hold, there is a possibility that HCA’s P/E is lower because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to HCA. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in HCA, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on HCA Healthcare for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
