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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 LHC Group, Inc.'s (NASDAQ:LHCG), to help you decide if the stock is worth further research. Based on the last twelve months, LHC Group's P/E ratio is 45. That is equivalent to an earnings yield of about 2.2%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for LHC Group:
P/E of 45 = $113.28 ÷ $2.52 (Based on the trailing twelve months to March 2019.)
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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
LHC Group saw earnings per share decrease by 2.1% last year. But over the longer term (5 years) earnings per share have increased by 16%.
How Does LHC Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that LHC Group has a higher P/E than the average (22.2) P/E for companies in the healthcare industry.
That means that the market expects LHC Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Is Debt Impacting LHC Group's P/E?
Net debt totals just 8.0% of LHC Group's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On LHC Group's P/E Ratio
LHC Group trades on a P/E ratio of 45, which is above the US market average of 17. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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.
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 firstname.lastname@example.org. 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.