Shenzhen Honor Electronic Co., Ltd. (SZSE:300870) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 44% share price drop.

Although its price has dipped substantially, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Shenzhen Honor Electronic as a stock to potentially avoid with its 34.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Shenzhen Honor Electronic certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Shenzhen Honor Electronic's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Shenzhen Honor Electronic's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 82% last year. Still, incredibly EPS has fallen 57% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next year should generate growth of 130% as estimated by the dual analysts watching the company. That's shaping up to be materially higher than the 41% growth forecast for the broader market.

With this information, we can see why Shenzhen Honor Electronic is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

Shenzhen Honor Electronic's P/E hasn't come down all the way after its stock plunged. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Shenzhen Honor Electronic'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.

Having said that, be aware Shenzhen Honor Electronic is showing 2 warning signs in our investment analysis, and 1 of those can't be ignored.

Of course, you might also be able to find a better stock than Shenzhen Honor Electronic. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.