Alexion Pharmaceuticals Inc (NASDAQ:ALXN) is trading with a trailing P/E of 51.9x, which is higher than the industry average of 27x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Alexion Pharmaceuticals
Breaking down the P/E 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 ALXN
Price-Earnings Ratio = Price per share ÷ Earnings per share
ALXN Price-Earnings Ratio = $117.15 ÷ $2.259 = 51.9x
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 ALXN, 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. Since ALXN’s P/E of 51.9x is higher than its industry peers (27x), it means that investors are paying more than they should for each dollar of ALXN’s earnings. Therefore, according to this analysis, ALXN is an over-priced stock.
A few caveats
Before you jump to the conclusion that ALXN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to ALXN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with ALXN, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing ALXN to are fairly valued by the market. If this does not hold true, ALXN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.