With a price-to-earnings (or "P/E") ratio of 10.1x Cabot Corporation (NYSE:CBT) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 34x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
For example, consider that Cabot's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
See our latest analysis for Cabot
How Is Cabot's Growth Trending?
There's an inherent assumption that a company should underperform the market for P/E ratios like Cabot's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 8.8%. Still, the latest three year period has seen an excellent 213% overall rise in EPS, in spite of its unsatisfying short-term performance. 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.
This is in contrast to the rest of the market, which is expected to grow by 15% over the next year, materially lower than the company's recent medium-term annualised growth rates.
With this information, we find it odd that Cabot is trading at a P/E lower than the market. It looks like most investors are not convinced the company can maintain its recent growth rates.
What We Can Learn From Cabot's P/E?
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 Cabot revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.
You should always think about risks. Case in point, we've spotted 1 warning sign for Cabot you should be aware of.
You might be able to find a better investment than Cabot. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.