Guangdong Cellwise Microelectronics Co., Ltd. (SHSE:688325) shareholders are no doubt pleased to see that the share price has bounced 35% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 14% in the last twelve months.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Guangdong Cellwise Microelectronics as a stock to avoid entirely with its 57.5x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

It looks like earnings growth has deserted Guangdong Cellwise Microelectronics recently, which is not something to boast about. One possibility is that the P/E is high because investors think the benign earnings growth will improve to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Enough Growth For Guangdong Cellwise Microelectronics?

The only time you'd be truly comfortable seeing a P/E as steep as Guangdong Cellwise Microelectronics' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Still, the latest three year period was better as it's delivered a decent 11% overall rise in EPS. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Guangdong Cellwise Microelectronics' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

The strong share price surge has got Guangdong Cellwise Microelectronics' P/E rushing to great heights as well. 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 Guangdong Cellwise Microelectronics currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place 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 2 warning signs with Guangdong Cellwise Microelectronics (at least 1 which is potentially serious), and understanding these should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.