Cogstate Limited (ASX:CGS) shareholders have had their patience rewarded with a 27% share price jump in the last month. The annual gain comes to 106% following the latest surge, making investors sit up and take notice.
After such a large jump in price, Cogstate may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 23.9x, since almost half of all companies in Australia have P/E ratios under 20x and even P/E's lower than 12x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been advantageous for Cogstate as its earnings have been rising faster 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.
Check out 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.
If we review the last year of earnings growth, the company posted a terrific increase of 87%. The strong recent performance means it was also able to grow EPS by 36% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 12% per year as estimated by the dual analysts watching the company. With the market predicted to deliver 17% growth per year, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Cogstate is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on 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. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
Our examination of Cogstate's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
A lot of potential risks can sit within a 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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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.