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Friday, August 21, 2020 4:03:23 PM
By: Simply Wall St. | August 18, 2020
With a price-to-earnings (or "P/E") ratio of 10.3x CVS Health Corporation (NYSE:CVS) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 20x and even P/E's higher than 39x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
Recent times have been pleasing for CVS Health as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like CVS Health's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 73% last year. As a result, it also grew EPS by 25% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 4.9% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 14% per annum growth forecast for the broader market.
In light of this, it's understandable that CVS Health's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.
The Final Word
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of CVS Health's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for CVS Health that you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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