Why Innospec Inc.'s (NASDAQ:IOSP) High P/E Ratio Isn't Necessarily A Bad Thing
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Innospec Inc.'s (NASDAQ:IOSP) P/E ratio and reflect on what it tells us about the company's share price. Innospec has a P/E ratio of 24.59, based on the last twelve months. In other words, at today's prices, investors are paying $24.59 for every $1 in prior year profit.
Check out our latest analysis for Innospec
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Innospec:
P/E of 24.59 = $92.16 ÷ $3.75 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Innospec's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Innospec has a higher P/E than the average (18.6) P/E for companies in the chemicals industry.
Its relatively high P/E ratio indicates that Innospec shareholders think it will perform better than other companies in its industry classification. 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
If earnings fall then in the future the 'E' will be lower. 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.
It's nice to see that Innospec grew EPS by a stonking 36% in the last year. And earnings per share have improved by 3.1% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 9.2% a year, over 3 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Innospec's P/E?
Net debt totals just 3.9% of Innospec's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Innospec's P/E Ratio
Innospec's P/E is 24.6 which is above average (18) in its market. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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 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. Thank you for reading.
