When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 15x, you may consider AstraZeneca PLC (LON:AZN) as a stock to avoid entirely with its 32.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
AstraZeneca certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
Check out our latest analysis for AstraZeneca
Is There Enough Growth For AstraZeneca?
There's an inherent assumption that a company should far outperform the market for P/E ratios like AstraZeneca's to be considered reasonable.
Retrospectively, the last year delivered a decent 10% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 287% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should generate growth of 28% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 14% each year growth forecast for the broader market.
With this information, we can see why AstraZeneca is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that AstraZeneca maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with AstraZeneca, and understanding these should be part of your investment process.
If these risks are making you reconsider your opinion on AstraZeneca, explore our interactive list of high quality stocks to get an idea of what else is out there.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About LSE:AZN
AstraZeneca
A biopharmaceutical company, focuses on the discovery, development, manufacture, and commercialization of prescription medicines.
Good value with reasonable growth potential.
