When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider UFP Technologies, Inc. (NASDAQ:UFPT) as a stock to avoid entirely with its 42.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

The recently shrinking earnings for UFP Technologies have been in line with the market. One possibility is that the P/E is high because investors think the company can turn things around and break free from the broader downward trend in earnings. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is UFP Technologies' Growth Trending?

UFP Technologies' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Although pleasingly EPS has lifted 202% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 18% over the next year. Meanwhile, the rest of the market is forecast to only expand by 15%, which is noticeably less attractive.

With this information, we can see why UFP Technologies is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On UFP Technologies' P/E

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.

As we suspected, our examination of UFP Technologies' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for UFP Technologies that you should be aware of.

You might be able to find a better investment than UFP Technologies. 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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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.