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Despite Its High P/E Ratio, Is Cognex Corporation (NASDAQ:CGNX) Still Undervalued?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Cognex Corporation's (NASDAQ:CGNX) P/E ratio and reflect on what it tells us about the company's share price. What is Cognex's P/E ratio? Well, based on the last twelve months it is 55.63. That means that at current prices, buyers pay $55.63 for every $1 in trailing yearly profits.

See our latest analysis for Cognex

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Cognex:

P/E of 55.63 = USD54.91 ÷ USD0.99 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does Cognex's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Cognex has a higher P/E than the average company (20.3) in the electronic industry.

NasdaqGS:CGNX Price Estimation Relative to Market, January 29th 2020

That means that the market expects Cognex will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Cognex earnings growth of 17% in the last year. And its annual EPS growth rate over 5 years is 9.5%. This could arguably justify a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Cognex's Debt Impact Its P/E Ratio?

The extra options and safety that comes with Cognex's US$414m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Cognex's P/E Ratio

Cognex trades on a P/E ratio of 55.6, which is above its market average of 18.6. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.