When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Ciena Corporation (NYSE:CIEN) as a stock to avoid entirely with its 46.9x 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.

With earnings that are retreating more than the market's of late, Ciena has been very sluggish. 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.

Is There Enough Growth For Ciena?

In order to justify its P/E ratio, Ciena would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. The last three years don't look nice either as the company has shrunk EPS by 55% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 34% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 10% per year, which is noticeably less attractive.

In light of this, it's understandable that Ciena's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Ciena's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Ciena with six simple checks will allow you to discover any risks that could be an issue.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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