Should You Be Tempted To Buy AstraZeneca PLC (LSE:AZN) At Its Current Price?
AstraZeneca PLC (LSE:AZN) is trading with a trailing P/E of 21.6x, which is lower than the industry average of 38.5x. While AZN 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for AstraZeneca
Demystifying 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 pound of the company’s earnings.
P/E Calculation for AZN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AZN Price-Earnings Ratio = 49.09 ÷ 3.057 = 21.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AZN, 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. At 21.6x, AZN’s P/E is lower than its industry peers (38.5x). This implies that investors are undervaluing each dollar of AZN’s earnings. Therefore, according to this analysis, AZN is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy AZN immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AZN, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with AZN, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing AZN to are fairly valued by the market. If this does not hold true, AZN’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? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of AZN to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in AZN, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 AstraZeneca 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.
