I agree that Pro Medicus Ltd (ASX: PME) shares are expensive, trading at a triple-digit earning multiple.
In an ideal world of investing, we all want to find high-quality companies trading at cheap multiples. But with so many eyes on the same pool of companies, it's often easier said than done.
If I had to choose between a cheap, mediocre company and a great growth company trading at high valuation multiples, I'd always go for the latter.
As Charlie Munger — the late business partner of Warren Buffett — said, it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Investing in these high-quality companies can pay off in the long run, even if it means paying a premium today.
Excellent business model
Pro Medicus provides advanced medical imaging software and services globally, especially doing well in the United States.
When you visit a doctor for issues like bone fractures or persistent headaches, there's a good chance you'll need medical imaging for an accurate diagnosis. Post-pandemic medical imaging has swiftly transitioned to digital methods, eliminating the need to carry physical X-ray or ultrasound films.
This digital shift enhances efficiency and accessibility, underscoring the importance of companies like Pro Medicus in modern healthcare.
Pro Medicus generates revenue from subscription fees as well as a small fee charged per each medical imaging done on its platform. To be specific, the revenue is based on a software-as-a-service model using transaction minimums. And there's further upside as client examination volumes grow over time. This is a great scalability.
In 1H FY24, its revenue grew 30% to $74.1 million, with an operating margin of 66%. Its net profit after tax was up 33% to $36.3 million.
The company is debt-free due to its strong operating cash flows and requires little capital investment to operate.
It ticks other investment considerations like a high insider ownership of approximately 52% and a high return on investment of 50%.
Expensive, for now
The Pro Medicus shares aren't cheap however you cut it. Using estimates by S&P Capital IQ, the shares are trading at:
- Price-to-earnings (P/E) multiple of 175x on FY24 earnings estimates
- P/E ratio of 134x on FY25 earnings estimates
- P/E ratio of 105x on FY26 earnings estimates
- Enterprise value to revenue multiple of 67x on FY25 estimates
- Free cash flow yield of 0.5%
- Dividend yield of 0.26%
But as you might have noticed, these earnings multiples rapidly reduce as we go out by a year. This is because of its healthy earnings growth.
Should we wait for a better entry point?
The Pro Medicus share price has nearly doubled in the past year, currently trading at $134.5. This might make you wonder if it's better to wait for the share price to weaken before investing.
I'm not completely against this idea, as events like another pandemic or economic downturns can impact the share market. The trouble is that it's impossible to predict when they might happen, so they often surprise the market.
Rather than waiting for the ideal moment, starting with a small investment now and gradually increasing it could be more beneficial in the long run, as any current price changes might appear minor in hindsight.
