China Northern Rare Earth (Group) High-Tech Co.,Ltd's (SHSE:600111) price-to-earnings (or "P/E") ratio of 39.2x 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 15x are quite common. 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.

While the market has experienced earnings growth lately, China Northern Rare Earth (Group) High-TechLtd'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?

There's an inherent assumption that a company should outperform the market for P/E ratios like China Northern Rare Earth (Group) High-TechLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 72% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 5.8% overall. 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 four analysts following the company. That's shaping up to be materially higher than the 23% per year growth forecast for the broader market.

With this information, we can see why China Northern Rare Earth (Group) High-TechLtd 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.

What We Can Learn From China Northern Rare Earth (Group) High-TechLtd's P/E?

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.

As we suspected, our examination of China Northern Rare Earth (Group) High-TechLtd'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. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - China Northern Rare Earth (Group) High-TechLtd has 1 warning sign we think you should be aware of.

Of course, you might also be able to find a better stock than China Northern Rare Earth (Group) High-TechLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.