Ciena Corporation (NYSE:CIEN) shares have had a horrible month, losing 31% after a relatively good period beforehand. Indeed, the recent drop has reduced its annual gain to a relatively sedate 2.4% over the last twelve months.
In spite of the heavy fall in price, you could still be forgiven for feeling indifferent about Ciena's P/E ratio of 16.8x, since the median price-to-earnings (or "P/E") ratio in the United States is also close to 18x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Ciena has been doing quite well of late. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Ciena.
How Is Ciena's Growth Trending?
There's an inherent assumption that a company should be matching the market for P/E ratios like Ciena's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 58%. The latest three year period has also seen an excellent 149% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 8.2% over the next year. With the market predicted to deliver 5.6% growth , that's a disappointing outcome.
With this information, we find it concerning that Ciena is trading at a fairly similar P/E to 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 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 Final Word
Following Ciena's share price tumble, its P/E is now hanging on to the median market P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Our examination of Ciena's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Ciena, and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on Ciena, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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