Those holding Luyuan Group Holding (Cayman) Limited (HKG:2451) shares would be relieved that the share price has rebounded 30% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider Luyuan Group Holding (Cayman) as a stock to avoid entirely with its 17.7x P/E ratio. 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.

The earnings growth achieved at Luyuan Group Holding (Cayman) over the last year would be more than acceptable for most companies. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Luyuan Group Holding (Cayman)'s is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 18% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 72% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 19% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Luyuan Group Holding (Cayman)'s 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Luyuan Group Holding (Cayman)'s P/E is flying high just like its stock has during the last month. 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 Luyuan Group Holding (Cayman) 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Luyuan Group Holding (Cayman) (1 is potentially serious) you should be aware of.

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.