Cognizant Technology Solutions Corporation's (NASDAQ:CTSH) Price Is Out Of Tune With Earnings

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Cognizant Technology Solutions Corporation (NASDAQ:CTSH) as a stock to potentially avoid with its 18.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings that are retreating more than the market's of late, Cognizant Technology Solutions has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Cognizant Technology Solutions

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Cognizant Technology Solutions.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Cognizant Technology Solutions' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 4.8%. Still, the latest three year period has seen an excellent 66% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.5% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 11% per annum, which is not materially different.

In light of this, it's curious that Cognizant Technology Solutions' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Cognizant Technology Solutions' P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Cognizant Technology Solutions' 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 Cognizant Technology Solutions with six simple checks on some of these key factors.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.