When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Encompass Health Corporation (NYSE:EHC) as a stock to potentially avoid with its 20x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Encompass Health has been doing quite well of late. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
How Is Encompass Health's Growth Trending?
Encompass Health's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 53% last year. Pleasingly, EPS has also lifted 31% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 7.4% per year during the coming three years according to the ten analysts following the company. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader market.
With this information, we find it concerning that Encompass Health is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
What We Can Learn From Encompass Health's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Encompass Health currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Before you take the next step, you should know about the 1 warning sign for Encompass Health that we have uncovered.
You might be able to find a better investment than Encompass Health. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
