Yahoo Finance Should You Be Tempted To Sell CVS Health Corporation (NYSE:CVS) At Its Current PE Ratio?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
CVS Health Corporation (NYSE:CVS) trades with a trailing P/E of 25.1x, which is higher than the industry average of 23.7x. While this makes CVS appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 CVS Health
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 CVS
Price-Earnings Ratio = Price per share ÷ Earnings per share
CVS Price-Earnings Ratio = $73.69 ÷ $2.94 = 25.1x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CVS, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. CVS’s P/E of 25.1x is higher than its industry peers (23.7x), which implies that each dollar of CVS’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Healthcare companies in US including LifeHOUSE Holdings, ALL-Q-TELL and Agility Health. Therefore, according to this analysis, CVS is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your CVS shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CVS, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with CVS, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing CVS to are fairly valued by the market. If this does not hold true, CVS’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 rebalance your portfolio and reduce your holdings in CVS. 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 CVS’s future growth? Take a look at our free research report of analyst consensus for CVS’s outlook.
Past Track Record: Has CVS 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 CVS’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.
