Nextool Technology Co., Ltd. (SHSE:688419) shares have had a really impressive month, gaining 36% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 10% in the last twelve months.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Nextool Technology's P/E ratio of 33x, since the median price-to-earnings (or "P/E") ratio in China is also close to 34x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Nextool Technology certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. 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.

What Are Growth Metrics Telling Us About The P/E?

In order to justify its P/E ratio, Nextool Technology 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 63% last year. EPS has also lifted 11% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 37% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it interesting that Nextool Technology is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.

What We Can Learn From Nextool Technology's P/E?

Its shares have lifted substantially and now Nextool Technology's P/E is also back up to the market median. 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 Nextool Technology currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Nextool Technology is showing 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

You might be able to find a better investment than Nextool Technology. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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