Shenzhen Hui Chuang Da Technology Co., Ltd. (SZSE:300909) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 28% in the last twelve months.

After such a large jump in price, Shenzhen Hui Chuang Da Technology's price-to-earnings (or "P/E") ratio of 48.6x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 30x and even P/E's below 18x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shenzhen Hui Chuang Da Technology's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Shenzhen Hui Chuang Da Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. As a result, earnings from three years ago have also fallen 48% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 39% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Shenzhen Hui Chuang Da Technology's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Shenzhen Hui Chuang Da Technology's P/E

The strong share price surge has got Shenzhen Hui Chuang Da Technology's P/E rushing to great heights as well. 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.

We've established that Shenzhen Hui Chuang Da Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Shenzhen Hui Chuang Da Technology you should be aware of.

If you're unsure about the strength of Shenzhen Hui Chuang Da Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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.