Is Cochlear Limited a Sell at today’s share price?

Cochlear Limited (ASX: COH) has seen its share price rise 33% in the past six months and more than 50% since September 2015 to around $124 currently.

But has it risen too far too fast and could we see a pullback?

Based on consensus earnings expectations of a net profit of around $190 million, Cochlear’s shares are currently trading on a prospective P/E ratio of roughly 37x. And that’s at the top end of management’s guidance.

That’s also expensive in anyone’s language – although nowhere near Domino’s Pizza Enterprises Ltd (ASX: DMP) nosebleed P/E of 71x 2016 financial year (FY16) results.

By comparison, CSL Limited (ASX: CSL) – arguably one of the best stocks on the ASX (if not the best) trades on a relatively conservative P/E ratio of 29x.

However, investors should not forget that a P/E ratio is relative. A company growing net profit and earnings at 32% over the previous year – like Cochlear did in the first half – deserves a premium P/E ratio.

In the first half of FY16, Cochlear saw sales revenue up 32% (16% in constant currency) and net profit up the same rate to $94 million. Growth of 26% in cochlear units was the main driver of rising revenues and after 3 steady years of unit sales, 2016 could see a substantial jump in the number of hearing implants sold.

Additional good news comes in the form of growing bone-anchored hearing systems, and the increasing base number of hearing aid recipients spending more on accessories and upgrades.

Cochlear is also growing its earnings before interest, tax (EBIT) margins – which rose from 22.9% to 23.5% in the first half of FY16. That may not seem like much but does indicate the company has some pricing power.

However, the company did warn of a number of risks that could see the company miss its guidance (see picture below). US seasonality, the majority of China tender units delivered in the first half, increased investment in the second half and a full year forecast exchange rate of US 72 cents. With the US dollar currently at 75.2 US cents and averaging around US73.7 cents, that will certainly create some friction against the company’s target.

Cochlear FY16 Outlook

Source: Cochlear Presentation


Foolish takeaway

Given the company’s own forecasts and the above potential headwinds suggests Cochlear will miss analysts’ expectations of a net profit near $190 million. That could see the share price marked down heavily next month when Cochlear reports its full year results.

That’s one of the dangers of buying shares at an expensive price – like Cochlear’s share price today.

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Motley Fool writer/analyst Mike King owns shares in Cochlear and CSL LImited. You can follow Mike on Twitter @TMFKinga

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.

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