EST Tools Co., Ltd (SZSE:300488) shareholders are no doubt pleased to see that the share price has bounced 25% in the last month, although it is still struggling to make up recently lost ground. Notwithstanding the latest gain, the annual share price return of 2.1% isn't as impressive.

In spite of the firm bounce in price, it's still not a stretch to say that EST Tools' price-to-earnings (or "P/E") ratio of 28.5x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 31x. 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.

Earnings have risen firmly for EST Tools recently, which is pleasing to see. One possibility is that the P/E is moderate because investors think this respectable earnings growth might not be enough to outperform the broader market in the near future. If that doesn't eventuate, then existing shareholders probably aren't too pessimistic about the future direction of the share price.

How Is EST Tools' Growth Trending?

The only time you'd be comfortable seeing a P/E like EST Tools' is when the company's growth is tracking the market closely.

Taking a look back first, we see that the company grew earnings per share by an impressive 22% last year. The strong recent performance means it was also able to grow EPS by 63% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 40% shows it's noticeably less attractive on an annualised basis.

With this information, we find it interesting that EST Tools is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.

The Final Word

Its shares have lifted substantially and now EST Tools' P/E is also back up to the market median. 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 EST Tools currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You always need to take note of risks, for example - EST Tools has 1 warning sign we think you should be aware of.

You might be able to find a better investment than EST Tools. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.