Ciena Corporation's (NYSE:CIEN) price-to-earnings (or "P/E") ratio of 29.5x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Ciena 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

Is There Enough Growth For Ciena?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Ciena's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 26% last year. Still, incredibly EPS has fallen 31% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 23% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 11% each year, which is noticeably less attractive.

With this information, we can see why Ciena is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

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.

As we suspected, our examination of Ciena's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Ciena with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than Ciena. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.