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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Ingredion Incorporated's (NYSE:INGR) P/E ratio and reflect on what it tells us about the company's share price. Ingredion has a P/E ratio of 13.88, based on the last twelve months. In other words, at today's prices, investors are paying $13.88 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ingredion:
P/E of 13.88 = $80.47 ÷ $5.8 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Ingredion saw earnings per share decrease by 22% last year. But over the longer term (5 years) earnings per share have increased by 4.3%. And EPS is down 2.5% a year, over the last 3 years. This might lead to low expectations.
How Does Ingredion's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Ingredion has a lower P/E than the average (24.1) P/E for companies in the food industry.
This suggests that market participants think Ingredion will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Ingredion's Debt Impact Its P/E Ratio?
Net debt is 37% of Ingredion's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Ingredion's P/E Ratio
Ingredion has a P/E of 13.9. That's below the average in the US market, which is 17.4. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Ingredion 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 firstname.lastname@example.org. 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.