Cadence Design Systems, Inc.'s (NASDAQ:CDNS) 32% Jump Shows Its Popularity With Investors

Cadence Design Systems, Inc. (NASDAQ:CDNS) shares have had a really impressive month, gaining 32% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 9.1% isn't as impressive.

Following the firm bounce in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Cadence Design Systems as a stock to avoid entirely with its 77.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Cadence Design Systems could be doing better as it's been growing earnings less than most other companies lately. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

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Is There Enough Growth For Cadence Design Systems?

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

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Still, the latest three year period has seen an excellent 45% overall rise in EPS, in spite of its uninspiring short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 17% per year over the next three years. That's shaping up to be materially higher than the 10% each year growth forecast for the broader market.

With this information, we can see why Cadence Design Systems is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Cadence Design Systems' P/E?

Shares in Cadence Design Systems have built up some good momentum lately, which has really inflated its P/E. 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 Cadence Design Systems maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Cadence Design Systems with six simple checks on some of these key factors.

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.

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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.