When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Cirrus Logic, Inc. (NASDAQ:CRUS) as a stock to avoid entirely with its 31.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Recent times haven't been advantageous for Cirrus Logic as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for Cirrus Logic

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Cirrus Logic's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 59%. As a result, earnings from three years ago have also fallen 2.6% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 19% each year as estimated by the eight analysts watching the company. With the market only predicted to deliver 13% per annum, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Cirrus Logic's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Cirrus Logic's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Cirrus Logic maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 2 warning signs for Cirrus Logic you should be aware of.

If you're unsure about the strength of Cirrus Logic'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.