It's not a stretch to say that Select Medical Holdings Corporation's (NYSE:SEM) price-to-earnings (or "P/E") ratio of 15.4x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 17x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been pleasing for Select Medical Holdings as its earnings have risen in spite of the market's earnings going into reverse. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

Does Growth Match The P/E?

In order to justify its P/E ratio, Select Medical Holdings would need to produce growth that's similar to the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 55% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 5.1% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 9.8% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 11% per annum, which is not materially different.

In light of this, it's understandable that Select Medical Holdings' P/E sits in line with the majority of other companies. It seems most investors are expecting to see average future growth and are only willing to pay a moderate amount for the stock.

The Bottom Line On Select Medical Holdings' P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Select Medical Holdings maintains its moderate P/E off the back of its forecast growth being in line with the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings won't throw up any surprises. It's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Before you take the next step, you should know about the 2 warning signs for Select Medical Holdings (1 makes us a bit uncomfortable!) that we have uncovered.

Of course, you might also be able to find a better stock than Select Medical Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.