Installed Building Products (NYSE:IBP) shareholders are no doubt pleased to see that the share price has bounced 36% in the last month alone, although it is still down 37% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 15% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Installed Building Products Have A Relatively High Or Low P/E For Its Industry?
Installed Building Products's P/E of 20.37 indicates some degree of optimism towards the stock. The image below shows that Installed Building Products has a higher P/E than the average (8.3) P/E for companies in the consumer durables industry.
That means that the market expects Installed Building Products will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Installed Building Products grew EPS by a whopping 30% in the last year. And it has improved its earnings per share by 23% per year over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
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. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Installed Building Products's P/E?
Installed Building Products's net debt equates to 26% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Installed Building Products's P/E Ratio
Installed Building Products trades on a P/E ratio of 20.4, which is above its market average of 14.5. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So to be frank we are not surprised it has a high P/E ratio. What we know for sure is that investors have become much more excited about Installed Building Products recently, since they have pushed its P/E ratio from 15.0 to 20.4 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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: Installed Building Products 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).
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.
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