Despite an already strong run, Espressif Systems (Shanghai) Co., Ltd. (SHSE:688018) shares have been powering on, with a gain of 35% in the last thirty days. Notwithstanding the latest gain, the annual share price return of 6.0% isn't as impressive.

Since its price has surged higher, Espressif Systems (Shanghai)'s price-to-earnings (or "P/E") ratio of 67.7x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 29x and even P/E's below 17x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Espressif Systems (Shanghai) certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

How Is Espressif Systems (Shanghai)'s Growth Trending?

Espressif Systems (Shanghai)'s P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 59%. EPS has also lifted 27% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 27% per annum during the coming three years according to the five analysts following the company. Meanwhile, the rest of the market is forecast to expand by 25% per year, which is not materially different.

With this information, we find it interesting that Espressif Systems (Shanghai) is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Espressif Systems (Shanghai)'s P/E

Espressif Systems (Shanghai)'s P/E is flying high just like its stock has during the last month. 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.

We've established that Espressif Systems (Shanghai) 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.

Having said that, be aware Espressif Systems (Shanghai) is showing 1 warning sign in our investment analysis, you should know about.

If you're unsure about the strength of Espressif Systems (Shanghai)'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.

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