Hengerda New Materials (Fujian) Co., Ltd. (SZSE:300946) shares have had a really impressive month, gaining 40% after a shaky period beforehand. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 6.4% in the last twelve months.

After such a large jump in price, Hengerda New Materials (Fujian) may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 41.3x, since almost half of all companies in China have P/E ratios under 33x and even P/E's lower than 20x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

For example, consider that Hengerda New Materials (Fujian)'s financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Hengerda New Materials (Fujian) would need to produce impressive growth in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 5.1%. The last three years don't look nice either as the company has shrunk EPS by 27% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 37% 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 Hengerda New Materials (Fujian)'s P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

Hengerda New Materials (Fujian)'s P/E is getting right up there since its shares have risen strongly. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Hengerda New Materials (Fujian) revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Hengerda New Materials (Fujian) (of which 1 makes us a bit uncomfortable!) you should know about.

If these risks are making you reconsider your opinion on Hengerda New Materials (Fujian), explore our interactive list of high quality stocks to get an idea of what else is out there.

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