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A Rising Share Price Has Us Looking Closely At Image Sensing Systems, Inc.'s (NASDAQ:ISNS) P/E Ratio

Simply Wall St

It's great to see Image Sensing Systems (NASDAQ:ISNS) shareholders have their patience rewarded with a 31% share price pop in the last month. The full year gain of 21% is pretty reasonable, too.

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). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Image Sensing Systems

How Does Image Sensing Systems's P/E Ratio Compare To Its Peers?

Image Sensing Systems's P/E of 4.07 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Image Sensing Systems has a lower P/E than the average (20.8) in the electronic industry classification.

NasdaqCM:ISNS Price Estimation Relative to Market, January 24th 2020

This suggests that market participants think Image Sensing Systems will underperform other companies in its industry. Since the market seems unimpressed with Image Sensing Systems, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, 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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

In the last year, Image Sensing Systems grew EPS like Taylor Swift grew her fan base back in 2010; the 271% gain was both fast and well deserved. And earnings per share have improved by 96% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting Image Sensing Systems's P/E?

With net cash of US$4.7m, Image Sensing Systems has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Image Sensing Systems's P/E Ratio

Image Sensing Systems trades on a P/E ratio of 4.1, which is below the US market average of 18.8. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What is very clear is that the market has become less pessimistic about Image Sensing Systems over the last month, with the P/E ratio rising from 3.1 back then to 4.1 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

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.