Yahoo Finance Does Dechra Pharmaceuticals PLC’s (LON:DPH) PE Ratio Warrant A Sell?
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Dechra Pharmaceuticals PLC (LON:DPH) trades with a trailing P/E of 58.5, which is higher than the industry average of 41.1. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Check out our latest analysis for Dechra Pharmaceuticals
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for DPH
Price-Earnings Ratio = Price per share ÷ Earnings per share
DPH Price-Earnings Ratio = £21.78 ÷ £0.372 = 58.5x
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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as DPH, 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 DPH’s P/E of 58.5 is higher than its industry peers (41.1), it means that investors are paying more for each dollar of DPH’s earnings. This multiple is a median of profitable companies of 9 Pharmaceuticals companies in GB including Redx Pharma, Alliance Pharma and Beximco Pharmaceuticals. You could think of it like this: the market is pricing DPH as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to DPH. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Dechra Pharmaceuticals PLC is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with DPH are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to DPH. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for DPH’s future growth? Take a look at our free research report of analyst consensus for DPH’s outlook.
Past Track Record: Has DPH 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 DPH’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.
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.
