There wouldn't be many who think Digiwin Software Co.,Ltd.'s (SZSE:300378) price-to-earnings (or "P/E") ratio of 27.6x is worth a mention when the median P/E in China is similar at about 28x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been advantageous for Digiwin SoftwareLtd as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

Does Growth Match The P/E?

In order to justify its P/E ratio, Digiwin SoftwareLtd would need to produce growth that's similar to the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 6.1% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 1.7% overall drop in EPS. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 20% per annum over the next three years. With the market predicted to deliver 25% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's curious that Digiwin SoftwareLtd's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Final Word

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.

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

Having said that, be aware Digiwin SoftwareLtd is showing 2 warning signs in our investment analysis, and 1 of those is concerning.

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.

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