This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use AstraZeneca PLC’s (LON:AZN) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, AstraZeneca’s P/E ratio is 39.93. That is equivalent to an earnings yield of about 2.5%.
See our latest analysis for AstraZeneca
How Do I Calculate AstraZeneca’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for AstraZeneca:
P/E of 39.93 = $76.34 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $1.91 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
AstraZeneca shrunk earnings per share by 32% over the last year. But over the longer term (5 years) earnings per share have increased by 7.3%.
How Does AstraZeneca’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that AstraZeneca has a P/E ratio that is roughly in line with the pharmaceuticals industry average (39.9).
That indicates that the market expects AstraZeneca will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting AstraZeneca’s P/E?
AstraZeneca has net debt worth 17% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On AstraZeneca’s P/E Ratio
AstraZeneca has a P/E of 39.9. That’s higher than the average in the GB market, which is 15.2. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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 AstraZeneca. 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).
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.