With a price-to-earnings (or "P/E") ratio of 27.1x CTS Corporation (NYSE:CTS) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
CTS' negative earnings growth of late has neither been better nor worse than most other companies. One possibility is that the P/E is high because investors think the company can turn things around and break free from the broader downward trend in earnings. If not, then existing shareholders may be a little nervous about the viability of the share price.
Is There Enough Growth For CTS?
The only time you'd be truly comfortable seeing a P/E as high as CTS' is when the company's growth is on track to outshine the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 2.5%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 51% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Turning to the outlook, the next year should generate growth of 21% as estimated by the one analyst watching the company. With the market only predicted to deliver 15%, the company is positioned for a stronger earnings result.
With this information, we can see why CTS is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that CTS maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.
Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for CTS with six simple checks on some of these key factors.
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.
