The Polyfair Holdings Limited (HKG:8532) share price has done very well over the last month, posting an excellent gain of 29%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 21% in the last twelve months.

After such a large jump in price, Polyfair Holdings' price-to-earnings (or "P/E") ratio of 34.3x might 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 8x and even P/E's below 5x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For example, consider that Polyfair Holdings' financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Polyfair Holdings?

Polyfair Holdings' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 59% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 36% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 22% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Polyfair Holdings is trading at a P/E higher than the market. 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Polyfair Holdings' P/E?

Shares in Polyfair Holdings have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Polyfair Holdings revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You need to take note of risks, for example - Polyfair Holdings has 4 warning signs (and 3 which shouldn't be ignored) we think you should know about.

You might be able to find a better investment than Polyfair Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.