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Despite Its High P/E Ratio, Is Lakeland Financial Corporation (NASDAQ:LKFN) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Lakeland Financial Corporation's (NASDAQ:LKFN), to help you decide if the stock is worth further research. Lakeland Financial has a P/E ratio of 13.49, based on the last twelve months. That corresponds to an earnings yield of approximately 7.4%.

See our latest analysis for Lakeland Financial

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 Lakeland Financial:

P/E of 13.49 = $45.27 ÷ $3.36 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Does Lakeland Financial's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below Lakeland Financial has a P/E ratio that is fairly close for the average for the banks industry, which is 12.6.

NasdaqGS:LKFN Price Estimation Relative to Market, September 18th 2019

That indicates that the market expects Lakeland Financial will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Lakeland Financial grew EPS by a whopping 28% in the last year. And earnings per share have improved by 15% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Lakeland Financial's Balance Sheet

Since Lakeland Financial holds net cash of US$50m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Lakeland Financial's P/E Ratio

Lakeland Financial's P/E is 13.5 which is below average (18.1) in the US market. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Lakeland Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.