When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may consider Jiangxi Xinyu Guoke Technology Co., Ltd (SZSE:300722) as a stock to avoid entirely with its 77.4x 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.

Jiangxi Xinyu Guoke Technology has been doing a decent job lately as it's been growing earnings at a reasonable pace. One possibility is that the P/E is high because investors think this good earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Jiangxi Xinyu Guoke Technology's Growth Trending?

Jiangxi Xinyu Guoke Technology'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 worthy increase of 2.8%. This was backed up an excellent period prior to see EPS up by 31% 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.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that Jiangxi Xinyu Guoke Technology 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Jiangxi Xinyu Guoke Technology currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for Jiangxi Xinyu Guoke Technology that you need to take into consideration.

Of course, you might also be able to find a better stock than Jiangxi Xinyu Guoke Technology. 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.