With a price-to-earnings (or "P/E") ratio of 39.9x Stepan Company (NYSE:SCL) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x 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 so lofty.
With earnings that are retreating more than the market's of late, Stepan has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
How Is Stepan's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as steep as Stepan's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 66%. This means it has also seen a slide in earnings over the longer-term as EPS is down 55% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 52% as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 13%, which is noticeably less attractive.
In light of this, it's understandable that Stepan's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Stepan maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
You always need to take note of risks, for example - Stepan has 3 warning signs we think you should be aware of.
If you're unsure about the strength of Stepan's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.