When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may consider Zhejiang Songyuan Automotive Safety Systems Co.,Ltd. (SZSE:300893) as a stock to potentially avoid with its 39.3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Zhejiang Songyuan Automotive Safety SystemsLtd has been doing quite well of late. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

Zhejiang Songyuan Automotive Safety SystemsLtd's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 35%. Pleasingly, EPS has also lifted 34% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 58% during the coming year according to the three analysts following the company. That's shaping up to be materially higher than the 41% growth forecast for the broader market.

With this information, we can see why Zhejiang Songyuan Automotive Safety SystemsLtd 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

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Zhejiang Songyuan Automotive Safety SystemsLtd'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.

It is also worth noting that we have found 1 warning sign for Zhejiang Songyuan Automotive Safety SystemsLtd that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.