PDL BioPharma Inc (NASDAQ:PDLI) trades with a trailing P/E of 5x, which is lower than the industry average of 28.5x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for PDL BioPharma
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in 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 PDLI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PDLI Price-Earnings Ratio = $2.45 ÷ $0.492 = 5x
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 PDLI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 5x, PDLI’s P/E is lower than its industry peers (28.5x). This implies that investors are undervaluing each dollar of PDLI’s earnings. Therefore, according to this analysis, PDLI is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy PDLI immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to PDLI. 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 PDLI, 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 PDLI to are fairly valued by the market. If this does not hold true, PDLI’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.