Investors Appear Satisfied With Cogstate Limited's (ASX:CGS) Prospects As Shares Rocket 51%

Cogstate Limited (ASX:CGS) shareholders would be excited to see that the share price has had a great month, posting a 51% gain and recovering from prior weakness. But not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 10% in the last twelve months.

After such a large jump in price, Cogstate may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 30.9x, since almost half of all companies in Australia have P/E ratios under 14x and even P/E's lower than 7x are not unusual. However, the P/E might be quite 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. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Keen to find out how analysts think Cogstate's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Cogstate's Growth Trending?

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

If we review the last year of earnings growth, the company posted a terrific increase of 42%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 22% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 13% per annum, which is noticeably less attractive.

With this information, we can see why Cogstate is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

The strong share price surge has got Cogstate's P/E rushing to great heights as well. 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.

We've established that Cogstate 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. It's hard to see the share price falling strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Cogstate that you should be aware of.

If these risks are making you reconsider your opinion on Cogstate, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.