Does Intuitive Surgical Inc’s (ISRG) PE Ratio Warrant A Sell?
Intuitive Surgical Inc (NASDAQ:ISRG) is currently trading at a trailing P/E of 47.6x, which is higher than the industry average of 42.6x. While ISRG might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Intuitive Surgical
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. 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 ISRG
Price-Earnings Ratio = Price per share ÷ Earnings per share
ISRG Price-Earnings Ratio = 1025.88 ÷ 21.538 = 47.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ISRG, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since ISRG's P/E of 47.6x is higher than its industry peers (42.6x), it means that investors are paying more than they should for each dollar of ISRG's earnings. As such, our analysis shows that ISRG represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ISRG should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to ISRG. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with ISRG, 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 ISRG to are fairly valued by the market. If this does not hold true, ISRG’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on ISRG, the overvaluation of the stock may mean it is a good time to reduce 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.
Are you a potential investor? If ISRG has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Intuitive Surgical for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
