Despite an already strong run, Ciena Corporation (NYSE:CIEN) shares have been powering on, with a gain of 28% in the last thirty days. The last 30 days bring the annual gain to a very sharp 46%.
After such a large jump in price, Ciena's price-to-earnings (or "P/E") ratio of 68.2x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings that are retreating more than the market's of late, Ciena has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Ciena's is when the company's growth is on track to outshine the market decidedly.
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 36%. As a result, earnings from three years ago have also fallen 68% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 42% per annum as estimated by the analysts watching the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.
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
Shares in Ciena have built up some good momentum lately, which has really inflated its 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 Ciena's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
You always need to take note of risks, for example - Ciena has 2 warning signs we think you should be aware of.
If you're unsure about the strength of Ciena's 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.
