The TOP Financial Group Limited (NASDAQ:TOP) share price has fared very poorly over the last month, falling by a substantial 63%. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

Although its price has dipped substantially, TOP Financial Group's price-to-earnings (or "P/E") ratio of 48x might still make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 14x and even P/E's below 8x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For instance, TOP Financial Group's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for TOP Financial Group

How Is TOP Financial Group's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like TOP Financial Group's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 31%. Still, the latest three year period has seen an excellent 288% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 8.3% shows it's noticeably more attractive on an annualised basis.

In light of this, it's understandable that TOP Financial Group's P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

Even after such a strong price drop, TOP Financial Group's P/E still exceeds the rest of the market significantly. 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.

We've established that TOP Financial Group maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with TOP Financial Group, and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than TOP Financial Group. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

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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.