EST Tools Co., Ltd's (SZSE:300488) Shares Climb 32% But Its Business Is Yet to Catch Up

EST Tools Co., Ltd (SZSE:300488) shareholders have had their patience rewarded with a 32% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 81% in the last year.

Even after such a large jump in price, it's still not a stretch to say that EST Tools' price-to-earnings (or "P/E") ratio of 37.7x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 35x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

EST Tools certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform 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 not quite in favour.

Check out our latest analysis for EST Tools

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on EST Tools' earnings, revenue and cash flow.

Does Growth Match The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like EST Tools' to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 36% last year. The latest three year period has also seen a 7.6% overall rise in EPS, aided extensively by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's noticeably less attractive on an annualised basis.

In light of this, it's curious that EST Tools' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

Its shares have lifted substantially and now EST Tools' P/E is also back up to the market median. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of EST Tools revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. Right now we are uncomfortable with the P/E as this earnings performance isn't likely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for EST Tools that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.