Should You Buy CVS Health Corporation (NYSE:CVS) At This PE Ratio?
CVS Health Corporation (NYSE:CVS) is trading with a trailing P/E of 9.3x, which is lower than the industry average of 21.1x. While CVS might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for CVS Health
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for CVS
Price-Earnings Ratio = Price per share ÷ Earnings per share
CVS Price-Earnings Ratio = $60.71 ÷ $6.537 = 9.3x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CVS, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. CVS’s P/E of 9.3x is lower than its industry peers (21.1x), which implies that each dollar of CVS’s earnings is being undervalued by investors. Therefore, according to this analysis, CVS is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy CVS immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CVS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CVS, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CVS to are fairly valued by the market. If this is violated, CVS’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to CVS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for CVS’s future growth? Take a look at our free research report of analyst consensus for CVS’s outlook.
Past Track Record: Has CVS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of CVS’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
