When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Hangzhou Honghua Digital Technology Stock Company LTD. (SHSE:688789) as a stock to potentially avoid with its 36.5x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Hangzhou Honghua Digital Technology Stock has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Hangzhou Honghua Digital Technology Stock's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Hangzhou Honghua Digital Technology Stock's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 40% last year. EPS has also lifted 26% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 23% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 25% per annum, which is not materially different.

In light of this, it's curious that Hangzhou Honghua Digital Technology Stock's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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.

We've established that Hangzhou Honghua Digital Technology Stock 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Hangzhou Honghua Digital Technology Stock that you should be aware of.

If these risks are making you reconsider your opinion on Hangzhou Honghua Digital Technology Stock, 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.