Those holding Newborn Town Inc. (HKG:9911) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. The last 30 days bring the annual gain to a very sharp 78%.

Although its price has surged higher, Newborn Town's price-to-earnings (or "P/E") ratio of 7x might still make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 10x and even P/E's above 19x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Newborn Town as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Is There Any Growth For Newborn Town?

The only time you'd be truly comfortable seeing a P/E as low as Newborn Town's is when the company's growth is on track to lag the market.

Retrospectively, the last year delivered an exceptional 139% gain to the company's bottom line. The latest three year period has also seen an excellent 544% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 5.5% per year over the next three years. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader market.

In light of this, it's understandable that Newborn Town's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

Despite Newborn Town's shares building up a head of steam, its P/E still lags most other companies. 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.

As we suspected, our examination of Newborn Town's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Newborn Town you should know about.

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.

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