When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Chengdu Xuguang Electronics Co., Ltd. (SHSE:600353) as a stock to avoid entirely with its 56.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

It looks like earnings growth has deserted Chengdu Xuguang Electronics recently, which is not something to boast about. It might be that many are expecting an improvement to the uninspiring earnings performance over the coming period, 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, Chengdu Xuguang Electronics would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Although pleasingly EPS has lifted 47% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has done a great job of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 37% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Chengdu Xuguang Electronics is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

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.

Our examination of Chengdu Xuguang Electronics revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Chengdu Xuguang Electronics with six simple checks on some of these key factors.

If you're unsure about the strength of Chengdu Xuguang Electronics' 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.

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