Those holding First Tractor Company Limited (HKG:38) shares would be relieved that the share price has rebounded 36% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

Even after such a large jump in price, it's still not a stretch to say that First Tractor's price-to-earnings (or "P/E") ratio of 8.5x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

With earnings growth that's exceedingly strong of late, First Tractor has been doing very well. 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 that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View our latest analysis for First Tractor

How Is First Tractor's Growth Trending?

In order to justify its P/E ratio, First Tractor 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 39% last year. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the market, which is predicted to deliver 18% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it interesting that First Tractor is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From First Tractor's P/E?

Its shares have lifted substantially and now First Tractor's P/E is also back up to the market median. 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.

Our examination of First Tractor revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for First Tractor that you should be aware of.

If these risks are making you reconsider your opinion on First Tractor, 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.