Should You Be Tempted To Sell Eli Lilly and Company (NYSE:LLY) Because Of Its PE Ratio?
Eli Lilly and Company (NYSE:LLY) trades with a trailing P/E of 79.9x, which is higher than the industry average of 23.5x. While LLY 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Eli Lilly
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for LLY
Price-Earnings Ratio = Price per share ÷ Earnings per share
LLY Price-Earnings Ratio = $85.49 ÷ $1.071 = 79.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as LLY, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. LLY’s P/E of 79.9x is higher than its industry peers (23.5x), which implies that each dollar of LLY’s earnings is being overvalued by investors. As such, our analysis shows that LLY represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that LLY 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 LLY. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with LLY, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing LLY to are fairly valued by the market. If this does not hold true, LLY’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on LLY, 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. 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 LLY’s future growth? Take a look at our free research report of analyst consensus for LLY’s outlook.
Past Track Record: Has LLY 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 LLY’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 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.
