The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Novo Nordisk A/S's (CPH:NOVO B), to help you decide if the stock is worth further research. Novo Nordisk has a price to earnings ratio of 26.37, based on the last twelve months. In other words, at today's prices, investors are paying DKK26.37 for every DKK1 in prior year profit.
How Do You Calculate Novo Nordisk's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Novo Nordisk:
P/E of 26.37 = DKK432.55 ÷ DKK16.41 (Based on the year to December 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each DKK1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Novo Nordisk's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below Novo Nordisk has a P/E ratio that is fairly close for the average for the pharmaceuticals industry, which is 25.1.
That indicates that the market expects Novo Nordisk will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Novo Nordisk saw earnings per share improve by -2.8% last year. And its annual EPS growth rate over 5 years is 10%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Novo Nordisk's Debt Impact Its P/E Ratio?
Novo Nordisk has net cash of ø15b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Novo Nordisk's P/E Ratio
Novo Nordisk's P/E is 26.4 which is above average (17.7) in its market. EPS was up modestly better over the last twelve months. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen!
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.