FONAR Corporation (NASDAQ:FONR) shareholders won't be pleased to see that the share price has had a very rough month, dropping 27% and undoing the prior period's positive performance. The last month has meant the stock is now only up 4.3% during the last year.

Since its price has dipped substantially, given about half the companies in the United States have price-to-earnings ratios (or "P/E's") above 17x, you may consider FONAR as an attractive investment with its 8.5x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

FONAR certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. 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 that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Is There Any Growth For FONAR?

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

If we review the last year of earnings growth, the company posted a terrific increase of 52%. The latest three year period has also seen an excellent 82% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 11% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we find it odd that FONAR is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Key Takeaway

The softening of FONAR's shares means its P/E is now sitting at a pretty low level. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of FONAR revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

You always need to take note of risks, for example - FONAR has 1 warning sign we think you should be aware of.

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