When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider DongGuan YuTong Optical Technology Co.,Ltd. (SZSE:300790) as a stock to avoid entirely with its 55.6x 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.

With earnings that are retreating more than the market's of late, DongGuan YuTong Optical TechnologyLtd has been very sluggish. 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 DongGuan YuTong Optical TechnologyLtd

Is There Enough Growth For DongGuan YuTong Optical TechnologyLtd?

DongGuan YuTong Optical TechnologyLtd'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 18%. This means it has also seen a slide in earnings over the longer-term as EPS is down 25% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 33% over the next year. That's shaping up to be materially lower than the 43% growth forecast for the broader market.

With this information, we find it concerning that DongGuan YuTong Optical TechnologyLtd is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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.

Our examination of DongGuan YuTong Optical TechnologyLtd's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with DongGuan YuTong Optical TechnologyLtd (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

Of course, you might also be able to find a better stock than DongGuan YuTong Optical TechnologyLtd. 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.