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Those holding Ingevity (NYSE:NGVT) shares must be pleased that the share price has rebounded 41% in the last thirty days. But unfortunately, the stock is still down by 52% over a quarter. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 64% share price decline throughout the 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business 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.
How Does Ingevity's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 9.03 that sentiment around Ingevity isn't particularly high. If you look at the image below, you can see Ingevity has a lower P/E than the average (17.2) in the chemicals industry classification.
Ingevity's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Ingevity, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Ingevity saw earnings per share improve by 9.2% last year. And it has bolstered its earnings per share by 7.5% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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.
So What Does Ingevity's Balance Sheet Tell Us?
Net debt totals 67% of Ingevity's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Ingevity's P/E Ratio
Ingevity trades on a P/E ratio of 9.0, which is below the US market average of 13.6. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations. What is very clear is that the market has become less pessimistic about Ingevity over the last month, with the P/E ratio rising from 6.4 back then to 9.0 today. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 be able to find a better stock than Ingevity. 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.
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