Is Valeant Pharmaceuticals International Inc (NYSE:VRX) A Buy At Its Current PE Ratio?
Valeant Pharmaceuticals International Inc (NYSE:VRX) is trading with a trailing P/E of 5.6x, which is lower than the industry average of 24.2x. 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. Check out our latest analysis for Valeant Pharmaceuticals International
Demystifying 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 VRX
Price-Earnings Ratio = Price per share ÷ Earnings per share
VRX Price-Earnings Ratio = $22.1 ÷ $3.931 = 5.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 VRX, 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. At 5.6x, VRX’s P/E is lower than its industry peers (24.2x). This implies that investors are undervaluing each dollar of VRX’s earnings. As such, our analysis shows that VRX represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy VRX immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to VRX, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with VRX, 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 VRX to are fairly valued by the market. If this does not hold true, VRX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to VRX. 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.
Are you a potential investor? If you are considering investing in VRX, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Valeant Pharmaceuticals International for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
