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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Innophos Holdings, Inc.’s (NASDAQ:IPHS) P/E ratio and reflect on what it tells us about the company’s share price. Innophos Holdings has a P/E ratio of 16.86, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Innophos Holdings:
P/E of 16.86 = $29.11 ÷ $1.73 (Based on the year to March 2019.)
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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. 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.
In the last year, Innophos Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 50% 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 7.5%. On the other hand, the longer term performance is poor, with EPS down 5.9% per year over 5 years.
Does Innophos Holdings 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. We can see in the image below that the average P/E (18.9) for companies in the chemicals industry is higher than Innophos Holdings’s P/E.
Its relatively low P/E ratio indicates that Innophos Holdings shareholders think it will struggle to do as well as other companies in its industry classification.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Innophos Holdings’s Balance Sheet
Innophos Holdings’s net debt is 54% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Innophos Holdings’s P/E Ratio
Innophos Holdings’s P/E is 16.9 which is about average (18.1) in the US market. The significant levels of debt do detract somewhat from the strong earnings growth. The P/E suggests the market isn’t confident that growth will be sustained, though.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Innophos Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 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.