InterDigital, Inc.'s (NASDAQ:IDCC) price-to-earnings (or "P/E") ratio of 13.6x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 17x and even P/E's above 31x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
Our free stock report includes 2 warning signs investors should be aware of before investing in InterDigital. Read for free now.Recent times have been advantageous for InterDigital as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
See our latest analysis for InterDigital
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like InterDigital's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 78% gain to the company's bottom line. Pleasingly, EPS has also lifted 677% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the six analysts covering the company suggest earnings growth is heading into negative territory, declining 18% per year over the next three years. With the market predicted to deliver 10% growth per year, that's a disappointing outcome.
In light of this, it's understandable that InterDigital's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
What We Can Learn From InterDigital's P/E?
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
As we suspected, our examination of InterDigital's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
Before you settle on your opinion, we've discovered 2 warning signs for InterDigital that you should be aware of.
Of course, you might also be able to find a better stock than InterDigital. 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.