It's A Story Of Risk Vs Reward With Inchcape plc (LON:INCH)

With a price-to-earnings (or "P/E") ratio of 11x Inchcape plc (LON:INCH) may be sending bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 17x and even P/E's higher than 29x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Inchcape certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Inchcape

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Is There Any Growth For Inchcape?

There's an inherent assumption that a company should underperform the market for P/E ratios like Inchcape's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.4% last year. However, due to its less than impressive performance prior to this period, EPS growth is practically non-existent over the last three years overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 16% per annum over the next three years. That's shaping up to be materially higher than the 13% per year growth forecast for the broader market.

With this information, we find it odd that Inchcape is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

What We Can Learn From Inchcape's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Inchcape currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Inchcape (1 is potentially serious!) that you should be aware of before investing here.

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 a strong growth track record, trading on a low P/E.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.