When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Encompass Health Corporation (NYSE:EHC) as a stock to potentially avoid with its 22.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Recent times have been pleasing for Encompass Health as its earnings have risen in spite of the market's earnings going into reverse. 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.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Encompass Health would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 21% gain to the company's bottom line. The latest three year period has also seen a 27% overall rise in EPS, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 6.3% per annum during the coming three years according to the eleven analysts following the company. That's shaping up to be materially lower than the 10% each year growth forecast for the broader market.

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. 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.

The Key Takeaway

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. 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.

It is also worth noting that we have found 1 warning sign for Encompass Health that you need to take into consideration.

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.