While Laboratory Corporation of America Holdings Inc (LH), which boasts a price-to-earnings ratio of 22.2x, may seem enticing, investors should exercise caution before taking the leap. LH’s high valuation compared to the broader U.S. market, which has a lower P/E ratio, warrants a closer look.
Earnings woes and high expectations:
LH’s recent woes are worrisome. Earnings per share (EPS) fell 40% last year, and the three-year growth rate is only 17%, raising questions about the company’s ability to justify its premium.
Despite past results, analysts are forecasting 14 per cent annual growth over the next three years, in line with the expected performance of the market as a whole. This begs the question: why does expected average growth lead to high P/E ratios?
A potential disappointment looms:
Investors seem optimistic and may be over-invested in LH because they are hoping for an exceptional turnaround beyond current expectations. If these lofty expectations fail to materialise, the P/E ratio is likely to fall significantly, leading to disappointment for existing shareholders.
Our view
We generally advise against relying exclusively on the P/E ratio for investment decisions. However, in the case of LH, the high valuation relative to average growth forecasts raises significant concerns. Unless future earnings significantly exceed current forecasts, the current price seems unsustainable.
We therefore recommend cautious optimism for LH, and while the potential for future growth exists, the current price may already take into account an overly optimistic scenario. Please assess the company’s future prospects carefully before making any investment decision.