With a median price-to-earnings (or "P/E") ratio of close to 29x in China, you could be forgiven for feeling indifferent about Amoy Diagnostics Co., Ltd.'s (SZSE:300685) P/E ratio of 26.4x. 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.

Amoy Diagnostics' earnings growth of late has been pretty similar to most other companies. The P/E is probably moderate because investors think this modest earnings performance will continue. If you like the company, you'd be hoping this can at least be maintained so that you could pick up some stock while it's not quite in favour.

Does Growth Match The P/E?

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

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Still, the latest three year period has seen an excellent 36% overall rise in EPS, in spite of its uninspiring short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 19% per annum as estimated by the ten analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 25% per year, which is noticeably more attractive.

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

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Amoy Diagnostics 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.

It is also worth noting that we have found 1 warning sign for Amoy Diagnostics that you need to take into consideration.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.

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