Novoray Corporation (SHSE:688300) shareholders won't be pleased to see that the share price has had a very rough month, dropping 25% and undoing the prior period's positive performance. Indeed, the recent drop has reduced its annual gain to a relatively sedate 3.0% over the last twelve months.

In spite of the heavy fall in price, Novoray's price-to-earnings (or "P/E") ratio of 40.4x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 31x and even P/E's below 19x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Novoray 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Novoray

Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a decent 2.6% gain to the company's bottom line. The latest three year period has also seen an excellent 90% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 32% during the coming year according to the three analysts following the company. That's shaping up to be materially lower than the 42% growth forecast for the broader market.

With this information, we find it concerning that Novoray 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 Bottom Line On Novoray's P/E

There's still some solid strength behind Novoray's P/E, if not its share price lately. 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.

Our examination of Novoray's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you settle on your opinion, we've discovered 2 warning signs for Novoray (1 is significant!) that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.