Yahoo Finance Does Cochlear Limited’s (ASX:COH) PE Ratio Signal A Selling Opportunity?
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Cochlear Limited (ASX:COH) is currently trading at a trailing P/E of 43.6, which is higher than the industry average of 28. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Cochlear
Breaking down the P/E 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 COH
Price-Earnings Ratio = Price per share ÷ Earnings per share
COH Price-Earnings Ratio = A$186.49 ÷ A$4.273 = 43.6x
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 COH, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 43.6, COH’s P/E is higher than its industry peers (28). This implies that investors are overvaluing each dollar of COH’s earnings. This multiple is a median of profitable companies of 6 Medical Equipment companies in AU including SDI, Ansell and Azure Healthcare. You could also say that the market is suggesting that COH is a stronger business than the average comparable company.
Assumptions to be aware of
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to COH. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Cochlear Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to COH may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on COH, 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for COH’s future growth? Take a look at our free research report of analyst consensus for COH’s outlook.
Past Track Record: Has COH 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 COH’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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
