This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Inter Parfums, Inc.’s (NASDAQ:IPAR) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Inter Parfums’s P/E ratio is 38.59. In other words, at today’s prices, investors are paying $38.59 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 Inter Parfums:
P/E of 38.59 = $61.88 ÷ $1.6 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Inter Parfums increased earnings per share by an impressive 21% over the last twelve months. And it has improved its earnings per share by 19% per year over the last three years. With that performance, you might expect an above average P/E ratio. Unfortunately, earnings per share are down 3.8% a year, over 5 years.
How Does Inter Parfums’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Inter Parfums has a higher P/E than the average company (21.2) in the personal products industry.
Inter Parfums’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
Inter Parfums’s Balance Sheet
Since Inter Parfums holds net cash of US$159m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Inter Parfums’s P/E Ratio
Inter Parfums has a P/E of 38.6. That’s higher than the average in the US market, which is 16.8. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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 Inter Parfums. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.