Those holding Nongfu Spring Co., Ltd. (HKG:9633) shares would be relieved that the share price has rebounded 31% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 19% in the last twelve months.

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 9x, you may consider Nongfu Spring as a stock to avoid entirely with its 28.6x P/E ratio. 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 have been advantageous for Nongfu Spring as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Nongfu Spring would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 30%. The latest three year period has also seen an excellent 94% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 12% growth each year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that Nongfu Spring is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Nongfu Spring's P/E

Shares in Nongfu Spring 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.

Our examination of Nongfu Spring's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Nongfu Spring, and understanding 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.