When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may consider Tianshui Huatian Technology Co., Ltd. (SZSE:002185) as a stock to avoid entirely with its 69.6x 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.

While the market has experienced earnings growth lately, Tianshui Huatian Technology's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Tianshui Huatian Technology's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 12%. As a result, earnings from three years ago have also fallen 64% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 29% per year during the coming three years according to the four analysts following the company. With the market only predicted to deliver 24% per year, the company is positioned for a stronger earnings result.

With this information, we can see why Tianshui Huatian Technology 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

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.

We've established that Tianshui Huatian Technology maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Tianshui Huatian Technology, and understanding should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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