Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Welgene Biotech Co.,Ltd.’s (GTSM:6661) P/E ratio could help you assess the value on offer. Welgene BiotechLtd has a price to earnings ratio of 15.32, based on the last twelve months. That is equivalent to an earnings yield of about 6.5%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Welgene BiotechLtd:
P/E of 15.32 = TWD25.30 ÷ TWD1.65 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each TWD1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Welgene BiotechLtd Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (47.9) for companies in the life sciences industry is higher than Welgene BiotechLtd’s P/E.
This suggests that market participants think Welgene BiotechLtd will underperform other companies in its industry. Since the market seems unimpressed with Welgene BiotechLtd, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Welgene BiotechLtd’s 99% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 10%. Regrettably, the longer term performance is poor, with EPS down 1.6% per year over 5 years.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Welgene BiotechLtd’s Debt Impact Its P/E Ratio?
Welgene BiotechLtd has net cash of NT$155m. This is fairly high at 30% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Welgene BiotechLtd’s P/E Ratio
Welgene BiotechLtd has a P/E of 15.3. That’s around the same as the average in the TW market, which is 16.1. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Welgene BiotechLtd to have a higher P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Welgene BiotechLtd. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.