What You Can Learn From Synopsys, Inc.'s (NASDAQ:SNPS) P/E

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Synopsys, Inc. (NASDAQ:SNPS) as a stock to avoid entirely with its 52.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times have been advantageous for Synopsys as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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How Is Synopsys' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Synopsys' is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 17%. Pleasingly, EPS has also lifted 88% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 15% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 11% per annum, which is noticeably less attractive.

In light of this, it's understandable that Synopsys' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Synopsys' 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.

We've established that Synopsys 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.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Synopsys with six simple checks.

If you're unsure about the strength of Synopsys' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.