Cogstate Limited (ASX:CGS) shares have continued their recent momentum with a 31% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 58% in the last year.
Following the firm bounce in price, Cogstate's price-to-earnings (or "P/E") ratio of 27.4x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 18x and even P/E's below 11x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Cogstate certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
See our latest analysis for Cogstate
How Is Cogstate's Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like Cogstate's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 19% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 16% per year as estimated by the two analysts watching the company. That's shaping up to be similar to the 15% each year growth forecast for the broader market.
In light of this, it's curious that Cogstate's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Final Word
The large bounce in Cogstate's shares has lifted the company's P/E to a fairly high level. 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.
Our examination of Cogstate's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Cogstate with six simple checks.
Of course, you might also be able to find a better stock than Cogstate. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Valuation is complex, but we're here to simplify it.
Discover if Cogstate might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.