EST Tools Co., Ltd's (SZSE:300488) price-to-earnings (or "P/E") ratio of 30.8x might make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 35x and even P/E's above 68x 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 quite advantageous for EST Tools as its earnings have been rising very briskly. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform 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 out of favour.

Is There Any Growth For EST Tools?

There's an inherent assumption that a company should underperform the market for P/E ratios like EST Tools' to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 36% last year. EPS has also lifted 7.6% 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.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's understandable that EST Tools' P/E sits below the majority of other companies. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

What We Can Learn From EST Tools' P/E?

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 EST Tools maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware EST Tools is showing 1 warning sign in our investment analysis, 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.

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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.