With a price-to-earnings (or "P/E") ratio of 63.5x Aehr Test Systems (NASDAQ:AEHR) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 14x and even P/E's lower than 7x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Aehr Test Systems certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Aehr Test Systems would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 210% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 5,829% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 5.9% shows it's noticeably more attractive on an annualised basis.

In light of this, it's understandable that Aehr Test Systems' P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Aehr Test Systems 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 4 warning signs with Aehr Test Systems (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Aehr Test Systems, 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.