Guangxi Guiguan Electric PowerCo.,Ltd.'s (SHSE:600236) price-to-earnings (or "P/E") ratio of 39.1x might 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 32x and even P/E's below 20x 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.

While the market has experienced earnings growth lately, Guangxi Guiguan Electric PowerCo.Ltd's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

Guangxi Guiguan Electric PowerCo.Ltd's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 49% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 39% in total over the last three years. 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 three years should generate growth of 41% per annum as estimated by the three analysts watching the company. That's shaping up to be materially higher than the 26% per annum growth forecast for the broader market.

With this information, we can see why Guangxi Guiguan Electric PowerCo.Ltd is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Guangxi Guiguan Electric PowerCo.Ltd maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Guangxi Guiguan Electric PowerCo.Ltd (at least 2 which can't be ignored), and understanding them should be part of your investment process.

You might be able to find a better investment than Guangxi Guiguan Electric PowerCo.Ltd. 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.