Zhejiang Tongxing Technology CO., Ltd. (SZSE:301252) shares have continued their recent momentum with a 29% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 33% in the last year.

Although its price has surged higher, it's still not a stretch to say that Zhejiang Tongxing Technology's price-to-earnings (or "P/E") ratio of 35.2x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 35x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

As an illustration, earnings have deteriorated at Zhejiang Tongxing Technology over the last year, which is not ideal at all. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Some Growth For Zhejiang Tongxing Technology?

In order to justify its P/E ratio, Zhejiang Tongxing Technology would need to produce growth that's similar to the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 12%. Still, the latest three year period has seen an excellent 31% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

This is in contrast to the rest of the market, which is expected to grow by 38% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's curious that Zhejiang Tongxing Technology's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Zhejiang Tongxing Technology's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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.

Our examination of Zhejiang Tongxing Technology revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. Right now we are uncomfortable with the P/E as this earnings performance isn't likely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhejiang Tongxing Technology (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.