This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Cadence Design Systems Inc’s (NASDAQ:CDNS) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Cadence Design Systems’s P/E ratio is 52.54. That corresponds to an earnings yield of approximately 1.9%.
How Do You Calculate Cadence Design Systems’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Cadence Design Systems:
P/E of 52.54 = $44.73 ÷ $0.85 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Cadence Design Systems shrunk earnings per share by 9.9% last year. But it has grown its earnings per share by 3.0% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 2.6% annually. So you wouldn’t expect a very high P/E.
How Does Cadence Design Systems’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Cadence Design Systems has a higher P/E than the average company (44.5) in the software industry.
Cadence Design Systems’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Cadence Design Systems’s P/E?
The extra options and safety that comes with Cadence Design Systems’s US$205m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Cadence Design Systems’s P/E Ratio
Cadence Design Systems trades on a P/E ratio of 52.5, which is multiples above the US market average of 17.5. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
But note: Cadence Design Systems may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.