Newcapec Electronics Co., Ltd. (SZSE:300248) shares have continued their recent momentum with a 37% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 21% is also fairly reasonable.

Since its price has surged higher, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 35x, you may consider Newcapec Electronics as a stock to potentially avoid with its 51.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Newcapec Electronics' financial performance has been poor lately as its earnings have been in decline. 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.

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

The only time you'd be truly comfortable seeing a P/E as high as Newcapec Electronics' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 11% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 23% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 40% shows it's an unpleasant look.

In light of this, it's alarming that Newcapec Electronics' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

The large bounce in Newcapec Electronics' shares has lifted the company's P/E to a fairly high level. 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.

Our examination of Newcapec Electronics 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. 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 need to take note of risks, for example - Newcapec Electronics has 3 warning signs (and 1 which is significant) we think you should know about.

Of course, you might also be able to find a better stock than Newcapec Electronics. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.