Hengxin Technology Ltd. (HKG:1085) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 22% in the last twelve months.

Since its price has surged higher, Hengxin Technology's price-to-earnings (or "P/E") ratio of 12.1x might make it look like a 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Hengxin Technology over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, 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.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Hengxin Technology's is when the company's growth is on track to outshine 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 46%. The last three years don't look nice either as the company has shrunk EPS by 26% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 22% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Hengxin Technology's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Hengxin Technology's P/E

Hengxin Technology shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Hengxin Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Hengxin Technology (1 is concerning) you should be aware of.

If you're unsure about the strength of Hengxin Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.