Huagong Tech Company Limited (SZSE:000988) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 64%.

Since its price has surged higher, Huagong Tech may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 35x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Huagong Tech certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Huagong Tech's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 45% gain to the company's bottom line. The latest three year period has also seen an excellent 90% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 35% as estimated by the nine analysts watching the company. With the market predicted to deliver 41% growth , the company is positioned for a weaker earnings result.

In light of this, it's alarming that Huagong Tech's P/E sits above the majority of other companies. 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

The large bounce in Huagong Tech's shares has lifted the company's P/E to a fairly high level. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Huagong Tech'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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for Huagong Tech that you need to take into consideration.

You might be able to find a better investment than Huagong Tech. 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.