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How Does Napco Security Technologies's (NASDAQ:NSSC) P/E Compare To Its Industry, After Its Big Share Price Gain?

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Napco Security Technologies (NASDAQ:NSSC) shareholders are no doubt pleased to see that the share price has bounced 40% in the last month alone, although it is still down 32% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 20% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for Napco Security Technologies

How Does Napco Security Technologies's P/E Ratio Compare To Its Peers?

Napco Security Technologies's P/E of 25.27 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (17.8) for companies in the electronic industry is lower than Napco Security Technologies's P/E.

NasdaqGS:NSSC Price Estimation Relative to Market May 1st 2020
NasdaqGS:NSSC Price Estimation Relative to Market May 1st 2020

Napco Security Technologies's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Napco Security Technologies grew EPS by a whopping 50% in the last year. And earnings per share have improved by 30% 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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

How Does Napco Security Technologies's Debt Impact Its P/E Ratio?

Since Napco Security Technologies holds net cash of US$12m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Napco Security Technologies's P/E Ratio

Napco Security Technologies has a P/E of 25.3. That's higher than the average in its market, which is 14.9. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Napco Security Technologies to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Napco Security Technologies over the last month, with the P/E ratio rising from 18.0 back then to 25.3 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.