United Therapeutics Corporation (NASDAQ:UTHR) is currently trading at a trailing P/E of 9.8x, which is lower than the industry average of 26.5x. While this makes UTHR 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 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 United Therapeutics
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 UTHR
Price-Earnings Ratio = Price per share ÷ Earnings per share
UTHR Price-Earnings Ratio = $108.5 ÷ $11.071 = 9.8x
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 UTHR, 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 9.8x, UTHR’s P/E is lower than its industry peers (26.5x). This implies that investors are undervaluing each dollar of UTHR’s earnings. Therefore, according to this analysis, UTHR is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that UTHR is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to UTHR, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with UTHR, 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 UTHR to are fairly valued by the market. If this does not hold true, UTHR’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on UTHR, 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for UTHR’s future growth? Take a look at our free research report of analyst consensus for UTHR’s outlook.
- Past Track Record: Has UTHR 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 UTHR’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.