This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how H. Lundbeck A/S’s (CPH:LUN) P/E ratio could help you assess the value on offer. Based on the last twelve months, H. Lundbeck’s P/E ratio is 14.93. That means that at current prices, buyers pay DKK14.93 for every DKK1 in trailing yearly profits.
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How Do You Calculate H. Lundbeck’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for H. Lundbeck:
P/E of 14.93 = DKK271 ÷ DKK18.15 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each DKK1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It’s great to see that H. Lundbeck grew EPS by 11% in the last year. And it has bolstered its earnings per share by 97% per year over the last five years. With that performance, you might expect an above average P/E ratio.
How Does H. Lundbeck’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (22.1) for companies in the pharmaceuticals industry is higher than H. Lundbeck’s P/E.
H. Lundbeck’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with H. Lundbeck, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does H. Lundbeck’s Debt Impact Its P/E Ratio?
Since H. Lundbeck holds net cash of ø4.5b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On H. Lundbeck’s P/E Ratio
H. Lundbeck trades on a P/E ratio of 14.9, which is below the DK market average of 16.6. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than H. Lundbeck. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.