Haohua Chemical Science & Technology Corp., Ltd.'s (SHSE:600378) price-to-earnings (or "P/E") ratio of 36.4x 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 26x and even P/E's below 16x 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, Haohua Chemical Science & Technology's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Haohua Chemical Science & Technology's Growth Trending?

In order to justify its P/E ratio, Haohua Chemical Science & Technology would need to produce impressive growth in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 31%. The last three years don't look nice either as the company has shrunk EPS by 7.0% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 19% per year over the next three years. With the market predicted to deliver 23% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Haohua Chemical Science & Technology's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Final Word

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.

We've established that Haohua Chemical Science & Technology currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Haohua Chemical Science & Technology has 2 warning signs we think you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.