Shenzhen Envicool Technology Co., Ltd.'s (SZSE:002837) price-to-earnings (or "P/E") ratio of 39.4x 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 34x 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.

Shenzhen Envicool Technology certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.

Check out our latest analysis for Shenzhen Envicool Technology

Is There Enough Growth For Shenzhen Envicool Technology?

In order to justify its P/E ratio, Shenzhen Envicool Technology would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 113%. The strong recent performance means it was also able to grow EPS by 99% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 44% over the next year. With the market predicted to deliver 44% growth , the company is positioned for a comparable earnings result.

In light of this, it's curious that Shenzhen Envicool Technology's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Shenzhen Envicool Technology currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Shenzhen Envicool Technology (1 makes us a bit uncomfortable!) that we have uncovered.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.