To the annoyance of some shareholders, Chengdu Zhimingda Electronics Co., Ltd. (SHSE:688636) shares are down a considerable 26% in the last month, which continues a horrid run for the company. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 41% share price drop.

Even after such a large drop in price, Chengdu Zhimingda Electronics' price-to-earnings (or "P/E") ratio of 30.9x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 17x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Chengdu Zhimingda Electronics certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Chengdu Zhimingda Electronics' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 19% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 35% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 42% each year during the coming three years according to the two analysts following the company. With the market only predicted to deliver 21% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Chengdu Zhimingda Electronics' 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 Final Word

Chengdu Zhimingda Electronics' P/E hasn't come down all the way after its stock plunged. 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.

As we suspected, our examination of Chengdu Zhimingda Electronics' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. 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.

You always need to take note of risks, for example - Chengdu Zhimingda Electronics has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Chengdu Zhimingda Electronics' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.