Xiamen Leading Optics Co., Ltd. (SHSE:605118) shares have continued their recent momentum with a 27% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 78% in the last year.

Since its price has surged higher, Xiamen Leading Optics may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 66.9x, since almost half of all companies in China have P/E ratios under 34x and even P/E's lower than 19x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For example, consider that Xiamen Leading Optics' financial performance has been poor lately as its earnings have been in decline. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Xiamen Leading Optics

Does Growth Match The High P/E?

Xiamen Leading Optics' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 22% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 26% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's an unpleasant look.

With this information, we find it concerning that Xiamen Leading Optics is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

Shares in Xiamen Leading Optics 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 Xiamen Leading Optics 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 2 warning signs for Xiamen Leading Optics (1 can't be ignored!) that you should be aware of.

You might be able to find a better investment than Xiamen Leading Optics. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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