It has been a stellar year for holders of Cochlear Limited (ASX: COH) with the share price rising over 40% in the last 12 months.

With its share price at record highs, many investors must be asking themselves is now the time to sell?

Valuation

Valuing a company is generally an easy process of running through a company’s financials and understanding its future growth prospects; but when it comes to what I would describe as “first class” companies, it becomes more difficult.

The long term price to earnings ratio for the Australian stockmarket is around 15. As most investors will be aware Cochlear rarely trades anywhere near this level. The reason behind this is because investors will assign a premium to companies which have outperformed the market for a long period.

So rather than looking at market averages, I prefer historical company figures combined with past and future growth rates. I also allow for the fact that demand for Cochlear’s individual products will rise and fall through the cycle. (Demand rises on the release of new products and declines over time until a new release or upgrade).

Earnings Guidance from Cochlear’s half-year report

  • Full year net profit guidance range adjusted to $180-190 million, up 23%-30% on FY15
  • Upgrades biased to H1 due to US seasonality
  • China tender – similar units to FY15 with majority delivered in H1
  • Investments in market expansion activities biased to H2
  • Full year forecast of 72c USD/AUD FX rate (previously 75c)

Key points

  • If we assume the upper level of guidance is met at the current price of $131, Cochlear is sitting on a PE of 39 compared with an historical average of closer to 30.
  • Mid-range guidance assumes mostly flat growth in NPAT compared to previous 6 months
  • US upgrades and China tenders will be down on previous 6 months.
  • USD/AUD has remained above the 72c forecast in half yearly guidance

Foolish takeaway

While Cochlear remains an excellent company, the share price in my opinion has moved ahead of what I consider fair value. As an investor in Cochlear I will watch for any information on new products in the pipeline along with how sales growth is being maintained in existing lines when the company reports on 9 August.

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Motley Fool contributor Alan Edmunds owns shares of Cochlear Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.