Despite an already strong run, Three Squirrels Inc. (SZSE:300783) shares have been powering on, with a gain of 32% in the last thirty days. The annual gain comes to 115% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Three Squirrels' price-to-earnings (or "P/E") ratio of 39.6x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 35x and even P/E's below 20x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Three Squirrels has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. 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?

Three Squirrels' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered an exceptional 94% gain to the company's bottom line. Still, incredibly EPS has fallen 18% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 25% as estimated by the eight analysts watching the company. With the market predicted to deliver 38% growth , the company is positioned for a weaker earnings result.

In light of this, it's alarming that Three Squirrels' P/E sits above the majority of other companies. 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.

The Final Word

Three Squirrels shares have received a push in the right direction, but its P/E is elevated too. 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.

Our examination of Three Squirrels' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Three Squirrels you should be aware of.

You might be able to find a better investment than Three Squirrels. 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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