With a price-to-earnings (or "P/E") ratio of 21.9x Encompass Health Corporation (NYSE:EHC) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 11x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Encompass Health as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Encompass Health.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Encompass Health's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 21% last year. Pleasingly, EPS has also lifted 34% 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.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 6.7% per annum over the next three years. With the market predicted to deliver 11% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Encompass Health's P/E sits above the majority of other companies. 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Encompass Health's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Encompass Health's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Encompass Health, and understanding should be part of your investment process.

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.