When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Incyte Corporation (NASDAQ:INCY) as a stock to avoid entirely with its 31x 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 so lofty.
Incyte has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Incyte's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 52% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 47% per annum as estimated by the analysts watching the company. With the market only predicted to deliver 12% each year, the company is positioned for a stronger earnings result.
With this information, we can see why Incyte is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From Incyte's P/E?
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 Incyte 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.
Plus, you should also learn about this 1 warning sign we've spotted with Incyte.
If these risks are making you reconsider your opinion on Incyte, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.