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Why Hill-Rom Holdings, Inc.'s (NYSE:HRC) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Hill-Rom Holdings, Inc.'s (NYSE:HRC), to help you decide if the stock is worth further research. Hill-Rom Holdings has a P/E ratio of 50.20, based on the last twelve months. That is equivalent to an earnings yield of about 2.0%.

View our latest analysis for Hill-Rom Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Hill-Rom Holdings:

P/E of 50.20 = $114.43 ÷ $2.28 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does Hill-Rom Holdings's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (45.9) for companies in the medical equipment industry is lower than Hill-Rom Holdings's P/E.

NYSE:HRC Price Estimation Relative to Market, January 10th 2020

That means that the market expects Hill-Rom Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Hill-Rom Holdings saw earnings per share decrease by 40% last year. But over the longer term (5 years) earnings per share have increased by 17%.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Hill-Rom Holdings's Balance Sheet Tell Us?

Hill-Rom Holdings has net debt equal to 29% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On Hill-Rom Holdings's P/E Ratio

Hill-Rom Holdings trades on a P/E ratio of 50.2, which is above its market average of 18.9. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Hill-Rom Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.