With a price-to-earnings (or "P/E") ratio of 21.1x Exelixis, Inc. (NASDAQ:EXEL) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Recent times have been pleasing for Exelixis as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
How Is Exelixis' Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like Exelixis' to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 127%. The strong recent performance means it was also able to grow EPS by 307% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 23% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.
With this information, we can see why Exelixis is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Exelixis maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Having said that, be aware Exelixis is showing 1 warning sign in our investment analysis, you should know about.
You might be able to find a better investment than Exelixis. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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