There's Reason For Concern Over IMCD N.V.'s (AMS:IMCD) Price

IMCD N.V.'s (AMS:IMCD) price-to-earnings (or "P/E") ratio of 27.9x might make it look like a strong sell right now compared to the market in the Netherlands, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, IMCD's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for IMCD

Keen to find out how analysts think IMCD's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For IMCD?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 5.3%. Regardless, EPS has managed to lift by a handy 29% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next three years should generate growth of 9.6% per annum as estimated by the analysts watching the company. With the market predicted to deliver 16% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that IMCD is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that IMCD currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with IMCD, and understanding should be part of your investment process.

You might be able to find a better investment than IMCD. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.