When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Innospec Inc. (NASDAQ:IOSP) as a stock to potentially avoid with its 23.2x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Innospec 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. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
How Is Innospec's Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like Innospec's to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 4.3%. The latest three year period has also seen an excellent 379% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 13% during the coming year according to the three analysts following the company. Meanwhile, the rest of the market is forecast to expand by 11%, which is not materially different.
With this information, we find it interesting that Innospec is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Key Takeaway
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 Innospec currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You always need to take note of risks, for example - Innospec has 1 warning sign we think you should be aware of.
Of course, you might also be able to find a better stock than Innospec. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.