Zhongji Innolight Co., Ltd. (SZSE:300308) shareholders have had their patience rewarded with a 29% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 39% in the last year.

Following the firm bounce in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 28x, you may consider Zhongji Innolight as a stock to avoid entirely with its 54.3x 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.

Zhongji Innolight 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Zhongji Innolight's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Zhongji Innolight's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 141% last year. The strong recent performance means it was also able to grow EPS by 204% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 46% each year over the next three years. With the market only predicted to deliver 25% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Zhongji Innolight's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

Shares in Zhongji Innolight have built up some good momentum lately, which has really inflated its P/E. 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 Zhongji Innolight maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Zhongji Innolight (of which 1 is concerning!) you should know about.

Of course, you might also be able to find a better stock than Zhongji Innolight. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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