Guangdong Aofei Data Technology Co., Ltd.'s (SZSE:300738) price-to-earnings (or "P/E") ratio of 62.4x 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 26x and even P/E's below 16x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times haven't been advantageous for Guangdong Aofei Data Technology 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.

Is There Enough Growth For Guangdong Aofei Data Technology?

In order to justify its P/E ratio, Guangdong Aofei Data Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. This means it has also seen a slide in earnings over the longer-term as EPS is down 5.4% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 55% per year during the coming three years according to the seven analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 19% each year, which is noticeably less attractive.

With this information, we can see why Guangdong Aofei Data Technology is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Guangdong Aofei Data Technology'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.

Before you settle on your opinion, we've discovered 3 warning signs for Guangdong Aofei Data Technology (2 are potentially serious!) that you should be aware of.

Of course, you might also be able to find a better stock than Guangdong Aofei Data Technology. 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.