When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 28x, you may consider Novoray Corporation (SHSE:688300) as a stock to avoid entirely with its 49.3x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Novoray certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Novoray would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 16% gain to the company's bottom line. Pleasingly, EPS has also lifted 52% 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 21% per annum as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 25% per annum, which is noticeably more attractive.

With this information, we find it concerning that Novoray is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Novoray's P/E?

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.

Our examination of Novoray's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Novoray, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Novoray, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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