Ausnutria Dairy Corporation Ltd (HKG:1717) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

After such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Ausnutria Dairy as a stock to avoid entirely with its 28x 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.

Ausnutria Dairy hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, 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?

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

Retrospectively, the last year delivered a frustrating 31% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 89% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 51% per annum over the next three years. With the market only predicted to deliver 12% per annum, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Ausnutria Dairy's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Ausnutria Dairy's P/E is flying high just like its stock has during the last month. 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 Ausnutria Dairy maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Plus, you should also learn about this 1 warning sign we've spotted with Ausnutria Dairy.

Of course, you might also be able to find a better stock than Ausnutria Dairy. 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.