It's not a stretch to say that Three Squirrels Inc.'s (SZSE:300783) price-to-earnings (or "P/E") ratio of 27x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 29x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

With earnings growth that's superior to most other companies of late, Three Squirrels 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 you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

How Is Three Squirrels' Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 113% last year. Still, incredibly EPS has fallen 21% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the 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 eight 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 interesting that Three Squirrels 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. 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

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 Three Squirrels currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Three Squirrels that we have uncovered.

If these risks are making you reconsider your opinion on Three Squirrels, 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