Cabot Corporation's (NYSE:CBT) price-to-earnings (or "P/E") ratio of 11x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 31x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
For example, consider that Cabot's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. 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 out of favour.
View our latest analysis for Cabot
How Is Cabot's Growth Trending?
There's an inherent assumption that a company should underperform the market for P/E ratios like Cabot's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 1.9%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 346% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Comparing that to the market, which is only predicted to deliver 14% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.
With this information, we find it odd that Cabot is trading at a P/E lower than the market. It looks like most investors are not convinced the company can maintain its recent growth rates.
What We Can Learn From Cabot's P/E?
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Cabot currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.
Plus, you should also learn about this 1 warning sign we've spotted with Cabot.
If you're unsure about the strength of Cabot's 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.