More Unpleasant Surprises Could Be In Store For Nova Ltd.'s (NASDAQ:NVMI) Shares After Tumbling 26%

The Nova Ltd. (NASDAQ:NVMI) share price has softened a substantial 26% over the previous 30 days, handing back much of the gains the stock has made lately. Longer-term, the stock has been solid despite a difficult 30 days, gaining 12% in the last year.

Although its price has dipped substantially, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may still consider Nova as a stock to avoid entirely with its 31.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times have been advantageous for Nova as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Nova

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Nova.

How Is Nova's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 33% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 91% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 12% per year during the coming three years according to the eight analysts following the company. With the market predicted to deliver 11% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Nova's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Nova's P/E?

Nova's shares may have retreated, but its P/E is still flying high. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Nova currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Nova with six simple checks will allow you to discover any risks that could be an issue.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.