CGI Inc.'s (TSE:GIB.A) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 15x, you may consider CGI Inc. (TSE:GIB.A) as a stock to potentially avoid with its 18.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Recent earnings growth for CGI has been in line with the market. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as CGI's is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a worthy increase of 8.7%. Pleasingly, EPS has also lifted 34% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 10% each year as estimated by the analysts watching the company. With the market predicted to deliver 11% growth each year, the company is positioned for a comparable earnings result.

In light of this, it's curious that CGI's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

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.

Our examination of CGI's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for CGI with six simple checks on some of these key factors.

Of course, you might also be able to find a better stock than CGI. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.