Chongqing Zongshen Power Machinery Co.,Ltd (SZSE:001696) shares have continued their recent momentum with a 37% gain in the last month alone. The annual gain comes to 144% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Chongqing Zongshen Power MachineryLtd's price-to-earnings (or "P/E") ratio of 46.5x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 31x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Chongqing Zongshen Power MachineryLtd's negative earnings growth of late has neither been better nor worse than most other companies. It might be that many expect the company's earnings to strengthen positively despite the tough market conditions, which has kept the P/E from falling. 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 high as Chongqing Zongshen Power MachineryLtd's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 24% decline in EPS over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 37% per annum as estimated by the one analyst watching the company. That's shaping up to be materially higher than the 18% per year growth forecast for the broader market.

In light of this, it's understandable that Chongqing Zongshen Power MachineryLtd'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 Bottom Line On Chongqing Zongshen Power MachineryLtd's P/E

Chongqing Zongshen Power MachineryLtd's P/E is getting right up there since its shares have risen strongly. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Chongqing Zongshen Power MachineryLtd's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Chongqing Zongshen Power MachineryLtd, and understanding them should be part of your investment process.

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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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.