The Hangzhou Todaytec Digital Co., Ltd (SZSE:300743) share price has fared very poorly over the last month, falling by a substantial 27%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 20% in that time.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Hangzhou Todaytec Digital as a stock to potentially avoid with its 31.9x 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.

The earnings growth achieved at Hangzhou Todaytec Digital over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

Hangzhou Todaytec Digital's 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 26% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 156% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 42% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Hangzhou Todaytec Digital's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

Despite the recent share price weakness, Hangzhou Todaytec Digital's P/E remains higher than most other companies. 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 Hangzhou Todaytec Digital currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Hangzhou Todaytec Digital is showing 3 warning signs 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.