With a price-to-earnings (or "P/E") ratio of 76x Zhejiang Sanmei Chemical Industry Co., Ltd. (SHSE:603379) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Zhejiang Sanmei Chemical Industry has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, 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.

See our latest analysis for Zhejiang Sanmei Chemical Industry

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

The only time you'd be truly comfortable seeing a P/E as steep as Zhejiang Sanmei Chemical Industry's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 65% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 6.8% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next year should generate growth of 138% as estimated by the two analysts watching the company. That's shaping up to be materially higher than the 42% growth forecast for the broader market.

In light of this, it's understandable that Zhejiang Sanmei Chemical Industry'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 Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Zhejiang Sanmei Chemical Industry'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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Zhejiang Sanmei Chemical Industry (1 is concerning) you should be aware of.

If these risks are making you reconsider your opinion on Zhejiang Sanmei Chemical Industry, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.