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Why Ramsay Health Care Limited's (ASX:RHC) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Ramsay Health Care Limited's (ASX:RHC), to help you decide if the stock is worth further research. Based on the last twelve months, Ramsay Health Care's P/E ratio is 36.27. That means that at current prices, buyers pay A$36.27 for every A$1 in trailing yearly profits.

Check out our latest analysis for Ramsay Health Care

How Do I Calculate Ramsay Health Care's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Ramsay Health Care:

P/E of 36.27 = A$72 ÷ A$1.99 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Ramsay Health Care has a higher P/E than the average company (17.5) in the healthcare industry.

ASX:RHC Price Estimation Relative to Market, July 28th 2019

Its relatively high P/E ratio indicates that Ramsay Health Care shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Ramsay Health Care's earnings per share fell by 14% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 8.0%.

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. 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.

Is Debt Impacting Ramsay Health Care's P/E?

Net debt is 37% of Ramsay Health Care's market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On Ramsay Health Care's P/E Ratio

Ramsay Health Care has a P/E of 36.3. That's higher than the average in its market, which is 16.3. 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

But note: Ramsay Health Care 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).

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.

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. Thank you for reading.