Shares of Medibank Private Ltd (ASX: MPL) have retreated nearly 10% over the last five weeks or so to be trading at $2.34, down from a high of $2.59. While some investors will no doubt see this as an opportunity to buy a high-quality stock at a discount, those investors could actually be committing themselves to years of underperformance.
Medibank Private is Australia's largest health insurer which fetched the Commonwealth Government $5.7 billion when it floated its shares on the ASX in November. As such, it is difficult to argue with the quality of the company but there are plenty of reasons to be concerned about its lofty valuation.
An enormous amount of hype has been priced into the shares, based on the market's expectations that the company can drastically reduce costs and improve productivity, thus driving profit growth higher. It's also likely that investors expect that Medibank Private will live up to the trend of previous government floats delivering outstanding shareholder returns – think Commonwealth Bank of Australia (ASX: CBA) and CSL Limited (ASX: CSL).
At its current price, the stock is trading at nearly 25 times forecast earnings. That compares to the average price-earnings ratio of almost 15 times, shared by Australia's top 200 companies which form the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
Although improvements to its cost base and growth in premiums could help drive earnings higher over the coming years, it appears that investors may have gotten ahead of themselves on this one. Until the stock falls to a more reasonable valuation, investors would be wise to avoid the temptation to buy and instead focus on some of the market's more compelling opportunities.
