With Cadence Design Systems, Inc. (NASDAQ:CDNS) It Looks Like You'll Get What You Pay For

Cadence Design Systems, Inc.'s (NASDAQ:CDNS) price-to-earnings (or "P/E") ratio of 71.8x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Cadence Design Systems certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Cadence Design Systems

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Cadence Design Systems.

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.

If we review the last year of earnings growth, the company posted a terrific increase of 23%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 11% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 21% per year over the next three years. With the market only predicted to deliver 13% per year, the company is positioned for a stronger earnings result.

With this information, we can see why Cadence Design Systems 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

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.

As we suspected, our examination of Cadence Design Systems' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

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.

If these risks are making you reconsider your opinion on Cadence Design Systems, 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.