Is It Time To Sell Magellan Health Inc (NASDAQ:MGLN) Based Off Its PE Ratio?
Magellan Health Inc (NASDAQ:MGLN) trades with a trailing P/E of 22.9x, which is higher than the industry average of 20.6x. While this makes MGLN appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Magellan Health
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 MGLN
Price-Earnings Ratio = Price per share ÷ Earnings per share
MGLN Price-Earnings Ratio = $107.95 ÷ $4.723 = 22.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MGLN, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since MGLN’s P/E of 22.9x is higher than its industry peers (20.6x), it means that investors are paying more than they should for each dollar of MGLN’s earnings. Therefore, according to this analysis, MGLN is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your MGLN shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MGLN, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MGLN, 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 MGLN to are fairly valued by the market. If this is violated, MGLN’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
