Despite Its High P/E Ratio, Is Level Biotechnology Inc. (GTSM:3118) Still Undervalued?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Level Biotechnology Inc.'s (GTSM:3118) P/E ratio and reflect on what it tells us about the company's share price. Level Biotechnology has a P/E ratio of 14.93, based on the last twelve months. That is equivalent to an earnings yield of about 6.7%.

See our latest analysis for Level Biotechnology

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Level Biotechnology:

P/E of 14.93 = NT$21.800 ÷ NT$1.460 (Based on the year to December 2019.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

How Does Level Biotechnology's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below Level Biotechnology has a P/E ratio that is fairly close for the average for the healthcare industry, which is 14.4.

Level Biotechnology's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Most would be impressed by Level Biotechnology earnings growth of 22% in the last year. In contrast, EPS has decreased by 9.2%, annually, over 5 years.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Level Biotechnology's Balance Sheet

Level Biotechnology has net cash of NT$344m. This is fairly high at 46% 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 Level Biotechnology's P/E Ratio

Level Biotechnology's P/E is 14.9 which is above average (12.9) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Level Biotechnology. 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 editorial-team@simplywallst.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.