With a price-to-earnings (or "P/E") ratio of 44.4x Cardinal Health, Inc. (NYSE:CAH) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. 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.
Recent times have been pleasing for Cardinal Health as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
How Is Cardinal Health's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Cardinal Health's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 28% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 42% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 50% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.
With this information, we can see why Cardinal Health 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 Cardinal Health'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.
We've established that Cardinal Health maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
You always need to take note of risks, for example - Cardinal Health has 3 warning signs we think you should be aware of.
You might be able to find a better investment than Cardinal Health. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com