It's not a stretch to say that Cognizant Technology Solutions Corporation's (NASDAQ:CTSH) price-to-earnings (or "P/E") ratio of 15.7x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 17x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Recent times haven't been advantageous for Cognizant Technology Solutions as its earnings have been falling quicker than most other companies. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders may be a little nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The P/E?
The only time you'd be comfortable seeing a P/E like Cognizant Technology Solutions' is when the company's growth is tracking the market closely.
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 7.1%. Even so, admirably EPS has lifted 47% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Turning to the outlook, the next three years should generate growth of 12% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 9.9% per year, which is not materially different.
In light of this, it's understandable that Cognizant Technology Solutions' P/E sits in line with the majority of other companies. Apparently shareholders are comfortable to simply hold on while the company is keeping a low profile.
The Final Word
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.
We've established that Cognizant Technology Solutions maintains its moderate P/E off the back of its forecast growth being in line with the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings won't throw up any surprises. It's hard to see the share price moving strongly in either direction in the near future under these circumstances.
There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Cognizant Technology Solutions that you should be aware of.
If you're unsure about the strength of Cognizant Technology Solutions' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.