Does Celgene Corporation’s (NASDAQ:CELG) PE Ratio Signal A Buying Opportunity?
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Celgene Corporation (NASDAQ:CELG) is trading with a trailing P/E of 22.2x, which is lower than the industry average of 24.2x. While CELG 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.
Check out our latest analysis for Celgene
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 CELG
Price-Earnings Ratio = Price per share ÷ Earnings per share
CELG Price-Earnings Ratio = $82.41 ÷ $3.704 = 22.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CELG, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 22.2, CELG’s P/E is lower than its industry peers (24.2). This implies that investors are undervaluing each dollar of CELG’s earnings. This multiple is a median of profitable companies of 24 Biotechs companies in US including Portage Biotech, Ophthotech and Concert Pharmaceuticals. One could put it like this: the market is pricing CELG as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to CELG, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with CELG, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing CELG to are fairly valued by the market. If this is violated, CELG’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on CELG, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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 highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for CELG’s future growth? Take a look at our free research report of analyst consensus for CELG’s outlook.
Past Track Record: Has CELG 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 CELG’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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
