80 Part One Value
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You would get a fairly good guide to the value of Johnson & Johnson if you looked at the
price-to-book ratios for the comparables, but the wide range of P/E ratios would give you a
hint that these ratios can be a treacherous benchmark in the pharmaceutical industry. You
would certainly want to discard outliers, such as Astra Zeneca’s P/E ratio.
The ratios for Devon Energy illustrate the potential difficulties with valuation by compa-
rables. The P/E ratios vary between 3.1 for Encana to 21.5 for Chesapeake Energy. Anadarko,
which was making a loss in 2014, did not even have a P/E ratio.
Such difficulties do not invalidate the use of comparables to value businesses. Maybe
Table 4.1 doesn’t show the most closely comparable companies. A financial manager or ana-
lyst would need to dig deeper to understand Devon’s industry and its competitors. Also the
method might work better with different ratios.^6 For example, P/E ratios are almost useless
as a guide to the value of new start-up companies, most of which do not have any earnings to
compare.(^6) Financial analysts often use ratios of EBIT (earnings before interest and taxes) or EBITDA (earnings before interest, taxes, deprecia-
tion, and amortization) to enterprise value (the sum of outstanding debt and the market cap of equity). EBIT or EBITDA ratios are less
sensitive than P/EPS ratios to differences in financing. In Chapter 19 we cover valuation when financing comes from a mix of debt
and equity. We discuss other ratios in Chapter 28.
Company Stock Price P/E P/B Comparable P/E P/B
Dow (chemicals) $42.71 14.0 2.3 BASF 12.6 2.3
Celanese 6.4 3.0
Dupont 20.5 4.0
Eastman Chemical 10.1 2.7
PPG 13.4 4.9
Average 12.6 3.4
Union Pacific (railroad) $112 20.7 4.6 Canadian Pacific 33.2 4.9
CSX 18.7 3.1
Kansas City Southern 25.9 3.4
Norfolk Southern 16.0 2.5
Average 23.5 3.5
Johnson & Johnson (health
care and pharmaceuticals)
$103 17.0 3.8 Astra Zeneca 85.3 4.3
Covidien 27.3 4.5
Merck 30.9 3.6
Novartis 21.1 3.1
Pfizer 18.9 2.5
Average 24.6 3.6
Devon Energy (oil and gas) $54 10.0 1.0 Anadarko n/a 1.8
Chesapeake Energy 21.5 0.9
Encana 3.1 0.9
EOG 15.3 2.6
Laredo Petroleum 8.3 0.8
Average 12.1 1.4
❱ TABLE 4.1 Stock price, price–earnings (P/E), and market–book (P/B) in December 2014.
Selected companies are compared to potential comparables.