When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 35x, you may consider Hangzhou Weiguang Electronic Co.,Ltd. (SZSE:002801) as a stock to potentially avoid with its 41.1x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Hangzhou Weiguang ElectronicLtd has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

Is There Enough Growth For Hangzhou Weiguang ElectronicLtd?

In order to justify its P/E ratio, Hangzhou Weiguang ElectronicLtd would need to produce impressive growth in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 51%. As a result, earnings from three years ago have also fallen 39% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the sole analyst covering the company suggest earnings should grow by 202% over the next year. Meanwhile, the rest of the market is forecast to only expand by 39%, which is noticeably less attractive.

With this information, we can see why Hangzhou Weiguang ElectronicLtd 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 Hangzhou Weiguang ElectronicLtd 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. Unless these conditions change, they will continue to provide strong support to the share price.

Before you settle on your opinion, we've discovered 3 warning signs for Hangzhou Weiguang ElectronicLtd that you should be aware of.

Of course, you might also be able to find a better stock than Hangzhou Weiguang ElectronicLtd. 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.