Hangzhou Zhengqiang Corporation Limited (SZSE:301119) shares have continued their recent momentum with a 32% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 4.4% in the last twelve months.

In spite of the firm bounce in price, you could still be forgiven for feeling indifferent about Hangzhou Zhengqiang's P/E ratio of 32.5x, since the median price-to-earnings (or "P/E") ratio in China is also close to 35x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

As an illustration, earnings have deteriorated at Hangzhou Zhengqiang over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Hangzhou Zhengqiang's Growth Trending?

There's an inherent assumption that a company should be matching the market for P/E ratios like Hangzhou Zhengqiang's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 12%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 27% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's noticeably less attractive on an annualised basis.

In light of this, it's curious that Hangzhou Zhengqiang's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.

The Final Word

Hangzhou Zhengqiang appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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.

We've established that Hangzhou Zhengqiang currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are uncomfortable with the P/E as this earnings performance isn't likely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Hangzhou Zhengqiang with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than Hangzhou Zhengqiang. 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.