When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider China Gas Holdings Limited (HKG:384) as a stock to potentially avoid with its 12.8x 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.

Recent times haven't been advantageous for China Gas Holdings as its earnings have been falling quicker than most other companies. 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.

Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 57%. As a result, earnings from three years ago have also fallen 71% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 27% per annum over the next three years. With the market only predicted to deliver 16% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that China Gas Holdings' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

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.

As we suspected, our examination of China Gas Holdings' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with China Gas Holdings (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.