Chinasoft International Limited's (HKG:354) price-to-earnings (or "P/E") ratio of 14.7x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Chinasoft International'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.

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

In order to justify its P/E ratio, Chinasoft International would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with earnings down 26% overall from three years ago. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 23% per year over the next three years. That's shaping up to be materially higher than the 16% per year growth forecast for the broader market.

With this information, we can see why Chinasoft International is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Chinasoft International's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Chinasoft International's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Chinasoft International with six simple checks.

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

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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.

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