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A Sliding Share Price Has Us Looking At Innospec Inc.'s (NASDAQ:IOSP) P/E Ratio

Simply Wall St
·4 mins read

To the annoyance of some shareholders, Innospec (NASDAQ:IOSP) shares are down a considerable 30% in the last month. Even longer term holders have taken a real hit with the stock declining 13% in the last year.

All else being equal, a share price drop should make a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.

View our latest analysis for Innospec

How Does Innospec's P/E Ratio Compare To Its Peers?

Innospec's P/E of 15.79 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Innospec has a lower P/E than the average (17.3) in the chemicals industry classification.

NasdaqGS:IOSP Price Estimation Relative to Market, March 12th 2020
NasdaqGS:IOSP Price Estimation Relative to Market, March 12th 2020

Innospec'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 Innospec, 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's nice to see that Innospec grew EPS by a stonking 32% in the last year. And it has bolstered its earnings per share by 5.9% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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 Innospec's P/E?

Since Innospec holds net cash of US$17m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Innospec's P/E Ratio

Innospec has a P/E of 15.8. That's higher than the average in its market, which is 14.7. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Innospec to have a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Innospec over the last month, with the P/E ratio falling from 22.7 back then to 15.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.

Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Innospec. 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 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.