This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Stepan Company’s ( NYSE:SCL ) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Stepan’s P/E ratio is 18.41 . That is equivalent to an earnings yield of about 5.4%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Stepan:
P/E of 18.41 = $76.55 ÷ $4.16 (Based on the year to September 2018.)
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. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Stepan saw earnings per share improve by -5.8% last year. And earnings per share have improved by 8.2% annually, over the last five years.
How Does Stepan’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (18.9) for companies in the chemicals industry is roughly the same as Stepan’s P/E.
That indicates that the market expects Stepan will perform roughly in line with other companies in its industry. So if Stepan actually outperforms its peers going forward, that should be a positive for the share price. I inform my view by by checking management tenure and remuneration , among other things.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Stepan’s Debt Impact Its P/E Ratio?
Net debt totals just 0.7% of Stepan’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Stepan’s P/E Ratio
Stepan’s P/E is 18.4 which is above average (16.5) in the US market. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course you might be able to find a better stock than Stepan . So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com .