How Does Napco Security Technologies's (NASDAQ:NSSC) P/E Compare To Its Industry, After Its Big Share Price Gain?

Napco Security Technologies (NASDAQ:NSSC) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 23% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Napco Security Technologies

How Does Napco Security Technologies's P/E Ratio Compare To Its Peers?

Napco Security Technologies's P/E of 26.63 indicates some degree of optimism towards the stock. As you can see below, Napco Security Technologies has a higher P/E than the average company (18.2) in the electronic industry.

That means that the market expects Napco Security Technologies will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Napco Security Technologies increased earnings per share by a whopping 36% last year. And it has bolstered its earnings per share by 33% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Napco Security Technologies's Balance Sheet Tell Us?

Napco Security Technologies has net cash of US$11m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Napco Security Technologies's P/E Ratio

Napco Security Technologies has a P/E of 26.6. That's higher than the average in its market, which is 14.7. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Napco Security Technologies to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Napco Security Technologies over the last month, with the P/E ratio rising from 20.3 back then to 26.6 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Napco Security Technologies. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. 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. Thank you for reading.