When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider Cerence Inc. (NASDAQ:CRNC) as a stock to potentially avoid with its 25.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Cerence 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. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Keen to find out how analysts think Cerence's future stacks up against the industry? In that case, our free report is a great place to start.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Cerence's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered an exceptional 387% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 45% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to slump, contracting by 24% per year during the coming three years according to the seven analysts following the company. Meanwhile, the broader market is forecast to expand by 13% per annum, which paints a poor picture.
With this information, we find it concerning that Cerence is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
The Bottom Line On Cerence's P/E
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of Cerence's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Plus, you should also learn about these 2 warning signs we've spotted with Cerence.
If you're unsure about the strength of Cerence's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
This article by Simply Wall St is general in nature. 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.
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