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This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Biotage AB (STO:BIOT) is trading with a trailing P/E of 52.3, which is higher than the industry average of 42.5. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for Biotage
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for BIOT
Price-Earnings Ratio = Price per share ÷ Earnings per share
BIOT Price-Earnings Ratio = SEK131 ÷ SEK2.504 = 52.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BIOT, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 52.3, BIOT’s P/E is higher than its industry peers (42.5). This implies that investors are overvaluing each dollar of BIOT’s earnings. Since the Life Sciences sector in SE is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as AddLife, Cellink and . You could also say that the market is suggesting that BIOT is a stronger business than the average comparable company.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to BIOT. If this isn’t the case, the difference in P/E could be due to other factors. For example, Biotage AB could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with BIOT are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.