Newborn Town Inc. (HKG:9911) shares have continued their recent momentum with a 31% gain in the last month alone. The annual gain comes to 205% following the latest surge, making investors sit up and take notice.

Although its price has surged higher, it's still not a stretch to say that Newborn Town's price-to-earnings (or "P/E") ratio of 9.5x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. 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.

With earnings growth that's superior to most other companies of late, Newborn Town has been doing relatively well. 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.

Is There Some Growth For Newborn Town?

The only time you'd be comfortable seeing a P/E like Newborn Town's 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 293% last year. Pleasingly, EPS has also lifted 1,006% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 6.3% per annum as estimated by the five analysts watching the company. With the market predicted to deliver 16% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's curious that Newborn Town'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. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Its shares have lifted substantially and now Newborn Town's P/E is also back up to the market median. 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 Newborn Town's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. 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.

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

If you're unsure about the strength of Newborn Town's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

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