Zhejiang Hechuan Technology Co., Ltd. (SHSE:688320) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 36% share price drop.

Even after such a large drop in price, Zhejiang Hechuan Technology may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 70.5x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Zhejiang Hechuan Technology hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. 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, Zhejiang Hechuan Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. As a result, earnings from three years ago have also fallen 63% overall. 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 71% as estimated by the two analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 36%, which is noticeably less attractive.

In light of this, it's understandable that Zhejiang Hechuan Technology's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

A significant share price dive has done very little to deflate Zhejiang Hechuan Technology's very lofty P/E. 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.

As we suspected, our examination of Zhejiang Hechuan Technology's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - Zhejiang Hechuan Technology has 2 warning signs we think you should be aware of.

If these risks are making you reconsider your opinion on Zhejiang Hechuan Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.