Espressif Systems (Shanghai) Co., Ltd. (SHSE:688018) shares have continued their recent momentum with a 36% gain in the last month alone. The annual gain comes to 137% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Espressif Systems (Shanghai) may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 65.2x, since almost half of all companies in China have P/E ratios under 37x and even P/E's lower than 21x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Espressif Systems (Shanghai) has been doing quite well of late. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

In order to justify its P/E ratio, Espressif Systems (Shanghai) would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 244% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 79% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 15% during the coming year according to the four analysts following the company. That's shaping up to be materially lower than the 38% growth forecast for the broader market.

With this information, we find it concerning that Espressif Systems (Shanghai) is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Espressif Systems (Shanghai)'s P/E?

The strong share price surge has got Espressif Systems (Shanghai)'s P/E rushing to great heights as well. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Espressif Systems (Shanghai) currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware Espressif Systems (Shanghai) is showing 1 warning sign in our investment analysis, you should know about.

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.