When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Sensient Technologies Corporation (NYSE:SXT) as a stock to avoid entirely with its 35.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times haven't been advantageous for Sensient Technologies as its earnings have been falling quicker than most other companies. 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 Sensient Technologies' Growth Trending?
Sensient Technologies' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
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 34%. The last three years don't look nice either as the company has shrunk EPS by 25% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 24% each year over the next three years. With the market only predicted to deliver 9.9% per annum, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Sensient Technologies' 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.
What We Can Learn From Sensient Technologies' P/E?
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.
As we suspected, our examination of Sensient Technologies' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 2 warning signs for Sensient Technologies that you should be aware of.
You might be able to find a better investment than Sensient Technologies. 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.