When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 35x, you may consider XGD Inc. (SZSE:300130) as a stock to potentially avoid with its 42.7x 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 as high as it is.

With earnings that are retreating more than the market's of late, XGD has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for XGD

Is There Enough Growth For XGD?

The only time you'd be truly comfortable seeing a P/E as high as XGD's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 21%. Still, the latest three year period has seen an excellent 155% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 216% over the next year. Meanwhile, the rest of the market is forecast to only expand by 43%, which is noticeably less attractive.

With this information, we can see why XGD 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 Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of XGD's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Plus, you should also learn about these 3 warning signs we've spotted with XGD.

Of course, you might also be able to find a better stock than XGD. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.