Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll apply a basic P/E ratio analysis to Vertex Pharmaceuticals Incorporated’s (NASDAQ:VRTX), to help you decide if the stock is worth further research. What is Vertex Pharmaceuticals’s P/E ratio? Well, based on the last twelve months it is 25.68. That means that at current prices, buyers pay $25.68 for every $1 in trailing yearly profits.
How Do You Calculate Vertex Pharmaceuticals’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Vertex Pharmaceuticals:
P/E of 25.68 = $215.07 ÷ $8.38 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Vertex Pharmaceuticals’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. The image below shows that Vertex Pharmaceuticals has a higher P/E than the average (17.4) P/E for companies in the biotechs industry.
Vertex Pharmaceuticals’s P/E tells us that market participants think the company will perform better than its industry peers, going forward.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Vertex Pharmaceuticals’s earnings made like a rocket, taking off 228% last year. Shareholders have some reason to be optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Vertex Pharmaceuticals’s Balance Sheet
Since Vertex Pharmaceuticals holds net cash of US$4.0b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Vertex Pharmaceuticals’s P/E Ratio
Vertex Pharmaceuticals’s P/E is 25.7 which is above average (18.0) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect Vertex Pharmaceuticals to have a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Vertex Pharmaceuticals may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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. Thank you for reading.