The Chongqing VDL Electronics Co., Ltd. (SZSE:301121) share price has done very well over the last month, posting an excellent gain of 30%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 19% in the last twelve months.

Following the firm bounce in price, Chongqing VDL Electronics' price-to-earnings (or "P/E") ratio of 77.6x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 32x and even P/E's below 20x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for Chongqing VDL Electronics as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

Is There Enough Growth For Chongqing VDL Electronics?

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

Retrospectively, the last year delivered an exceptional 70% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 83% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Chongqing VDL Electronics' P/E sits above the majority of other companies. 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.

What We Can Learn From Chongqing VDL Electronics' P/E?

Shares in Chongqing VDL Electronics have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that Chongqing VDL Electronics currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you settle on your opinion, we've discovered 3 warning signs for Chongqing VDL Electronics (2 shouldn't be ignored!) that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.