Yahoo Finance Should You Be Tempted To Buy Medibank Private Limited (ASX:MPL) Because Of Its PE Ratio?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Medibank Private Limited (ASX:MPL) is currently trading at a trailing P/E of 18.9x, which is lower than the industry average of 19.9x. While this makes MPL appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Medibank Private
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for MPL
Price-Earnings Ratio = Price per share ÷ Earnings per share
MPL Price-Earnings Ratio = A$3.06 ÷ A$0.162 = 18.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MPL, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 18.9, MPL’s P/E is lower than its industry peers (19.9). This implies that investors are undervaluing each dollar of MPL’s earnings. This multiple is a median of profitable companies of 10 Insurance companies in AU including Freedom Insurance Group, Suncorp Group and Suncorp Group. One could put it like this: the market is pricing MPL as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to MPL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with MPL, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing MPL to are fairly valued by the market. If this is violated, MPL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to MPL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for MPL’s future growth? Take a look at our free research report of analyst consensus for MPL’s outlook.
Past Track Record: Has MPL been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of MPL’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
