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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Quaker Chemical Corporation’s (NYSE:KWR) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Quaker Chemical’s P/E ratio is 44.45. That is equivalent to an earnings yield of about 2.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Quaker Chemical:
P/E of 44.45 = $202 ÷ $4.54 (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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Quaker Chemical grew EPS like Taylor Swift grew her fan base back in 2010; the 132% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn’t so good, coming in at 4.0%.
Does Quaker Chemical Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Quaker Chemical has a higher P/E than the average (18.1) P/E for companies in the chemicals industry.
Its relatively high P/E ratio indicates that Quaker Chemical shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
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).
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.
So What Does Quaker Chemical’s Balance Sheet Tell Us?
Quaker Chemical has net cash of US$60m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Quaker Chemical’s P/E Ratio
Quaker Chemical’s P/E is 44.5 which is above average (17.9) in the US market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Quaker Chemical. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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. Thank you for reading.