When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Xinyu Iron & Steel Co., Ltd (SHSE:600782) as a stock to avoid entirely with its 47.2x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Xinyu Iron & Steel certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like Xinyu Iron & Steel's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 126% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 92% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 83% each year over the next three years. That's shaping up to be materially higher than the 25% each year growth forecast for the broader market.

With this information, we can see why Xinyu Iron & Steel is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Xinyu Iron & Steel's 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 Xinyu Iron & Steel'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. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Xinyu Iron & Steel (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

If you're unsure about the strength of Xinyu Iron & Steel's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.