Some Confidence Is Lacking In Nanosonics Limited (ASX:NAN) As Shares Slide 33%

Nanosonics Limited (ASX:NAN) shareholders won't be pleased to see that the share price has had a very rough month, dropping 33% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 40% share price drop.

In spite of the heavy fall in price, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may still consider Nanosonics as a stock to avoid entirely with its 44.3x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Nanosonics as its earnings have risen in spite of the market's earnings going into reverse. 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.

See our latest analysis for Nanosonics

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Does Growth Match The High P/E?

Nanosonics' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 431% last year. The latest three year period has also seen an excellent 95% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 9.1% per annum over the next three years. With the market predicted to deliver 17% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Nanosonics is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 growth outlook.

The Key Takeaway

A significant share price dive has done very little to deflate Nanosonics' very lofty 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.

We've established that Nanosonics currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Nanosonics with six simple checks.

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 a strong growth track record, trading on a low P/E.

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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.