The FIT Hon Teng Limited (HKG:6088) share price has softened a substantial 25% over the previous 30 days, handing back much of the gains the stock has made lately. Looking at the bigger picture, even after this poor month the stock is up 94% in the last year.

Although its price has dipped substantially, FIT Hon Teng's price-to-earnings (or "P/E") ratio of 18.3x might still make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

FIT Hon Teng could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour 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.

Does Growth Match The High P/E?

In order to justify its P/E ratio, FIT Hon Teng 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 25%. Even so, admirably EPS has lifted 186% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 36% per year as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 15% per year, which is noticeably less attractive.

With this information, we can see why FIT Hon Teng is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From FIT Hon Teng's P/E?

A significant share price dive has done very little to deflate FIT Hon Teng's very lofty P/E. 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 FIT Hon Teng maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.

Having said that, be aware FIT Hon Teng is showing 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant.

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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