No matter which way you look at it, shares of the newly-listed Medibank Private Ltd (ASX: MPL) are not cheap.
After it opened for $2.22 on Tuesday 25 November, the stock closed for the week trading at $2.17 – an 8.5% premium to the price retail investors paid for the float – which puts it on a P/E ratio of roughly 23.1 times earnings. By comparison, the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) trades on an average P/E ratio of 15.2 times, while fellow-listed health insurer NIB Holdings Limited (ASX: NHF) trades on 19.3 times earnings.
While hype and demand from institutional investors is likely to keep the share price elevated in the coming weeks and months, there is a good chance we could see the stock return to a more reasonable level in 2015.
Here's why…
A stock like Medibank Private was always going to attract a lot of attention early on. Not only do Government-listed businesses such as Commonwealth Bank of Australia (ASX: CBA) and CSL Limited (ASX: CSL) have a strong track record for incredible shareholder returns, the IPO was also one of the ASX's most highly anticipated floats in recent memory, eclipsed only by the partial float of Telstra Corporation Ltd (ASX: TLS) in 1999.
But it seems as though much of the demand for shares was based on hype, as opposed to basic investing fundamentals. Medibank is a good business, but it also has a lot of shortfalls which could severely impact its ability to live up to investor expectations.
To begin with, given its sheer size, it will struggle to gain more market share. As such, most of its growth prospects are embedded in management's ability to reduce costs and improve overall margins. With a P/E ratio of over 23, it appears that investors expect these improvements will be made in the very near future – a scenario I don't see happening considering few improvements have been made in the last 13 years.
While the rewards could be great if the company does make these necessary improvements, I expect investors could be disappointed with the results which could see them run for the exits, forcing the share price down.
A reasonable price to pay
While I wouldn't touch Medibank's shares at their current price, I have added the stock to my watchlist in the hope it will fall to a more reasonable valuation. Although I don't have an exact price I would be willing to pay (after all, valuation is never an exact science), I would certainly consider making a purchase if the shares fell to around $1.70 or so – around the mid-way point of their initial indicative price range.
Until then, there are a number of other companies trading at compelling prices which could be set to deliver investors with far greater profits than Medibank in the years ahead.
