With a price-to-earnings (or "P/E") ratio of 79x Espressif Systems (Shanghai) Co., Ltd. (SHSE:688018) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 34x and even P/E's lower than 20x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times haven't been advantageous for Espressif Systems (Shanghai) as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

View our latest analysis for Espressif Systems (Shanghai)

Does Growth Match The High P/E?

Espressif Systems (Shanghai)'s P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than 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 25%. As a result, earnings from three years ago have also fallen 30% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 79% as estimated by the seven analysts watching the company. With the market only predicted to deliver 44%, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Espressif Systems (Shanghai)'s P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Espressif Systems (Shanghai)'s P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Espressif Systems (Shanghai) maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Espressif Systems (Shanghai) with six simple checks on some of these key factors.

You might be able to find a better investment than Espressif Systems (Shanghai). If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.