Yahoo Finance Should You Be Tempted To Buy Cardinal Health Inc (NYSE:CAH) Because Of Its PE Ratio?
Cardinal Health Inc (NYSE:CAH) is trading with a trailing P/E of 9.7x, which is lower than the industry average of 21.9x. While this makes CAH appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Cardinal Health
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in 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.
P/E Calculation for CAH
Price-Earnings Ratio = Price per share ÷ Earnings per share
CAH Price-Earnings Ratio = $52.44 ÷ $5.401 = 9.7x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CAH, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. CAH’s P/E of 9.7x is lower than its industry peers (21.9x), which implies that each dollar of CAH’s earnings is being undervalued by investors. As such, our analysis shows that CAH represents an under-priced stock.
A few caveats
However, before you rush out to buy CAH, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CAH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CAH, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CAH to are fairly valued by the market. If this is violated, CAH’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on CAH, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 CAH’s future growth? Take a look at our free research report of analyst consensus for CAH’s outlook.
Past Track Record: Has CAH 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 CAH’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 pass 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.
