Tiangong International Company Limited (HKG:826) shares have had a really impressive month, gaining 29% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 5.9% over the last year.

Since its price has surged higher, Tiangong International's price-to-earnings (or "P/E") ratio of 16.6x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Tiangong International hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Tiangong International would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 21%. This means it has also seen a slide in earnings over the longer-term as EPS is down 48% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 13% per annum as estimated by the dual analysts watching the company. With the market predicted to deliver 12% growth each year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that Tiangong International 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. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Shares in Tiangong International have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Tiangong International 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.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Tiangong International with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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