The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Walgreens Boots Alliance Inc (NASDAQ:WBA)’s fundamentals and stock market performance.
Walgreens Boots Alliance Inc (NASDAQ:WBA) trades with a trailing P/E of 16.8x, which is lower than the industry average of 21.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 Walgreens Boots Alliance
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for WBA
Price per share = $67.24
Earnings per share = $4.004
∴ Price-Earnings Ratio = $67.24 ÷ $4.004 = 16.8x
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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as WBA, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
At 16.8x, WBA’s P/E is lower than its industry peers (21.2x). This implies that investors are undervaluing each dollar of WBA’s earnings. As such, our analysis shows that WBA represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy WBA, 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 WBA. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing lower risk firms with WBA, then WBA’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with WBA. In this case, WBA’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing WBA to are fairly valued by the market. If this assumption is violated, WBA’s P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of WBA to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for WBA’s future growth? Take a look at our free research report of analyst consensus for WBA’s outlook.
- Past Track Record: Has WBA 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 WBA’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.