Should You Be Tempted To Sell GlaxoSmithKline plc (NYSE:GSK) At Its Current PE Ratio?
GlaxoSmithKline plc (NYSE:GSK) is currently trading at a trailing P/E of 41.2x, which is higher than the industry average of 22.2x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 GlaxoSmithKline
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 dollar of the company’s earnings.
P/E Calculation for GSK
Price-Earnings Ratio = Price per share ÷ Earnings per share
GSK Price-Earnings Ratio = £12.91 ÷ £0.314 = 41.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to GSK, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 41.2x, GSK’s P/E is higher than its industry peers (22.2x). This implies that investors are overvaluing each dollar of GSK’s earnings. Therefore, according to this analysis, GSK is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your GSK shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to GSK. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with GSK, 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 GSK to are fairly valued by the market. If this does not hold, there is a possibility that GSK’s P/E is lower because our peer group is 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.
