Chinasoft International Limited (HKG:354) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 15% in the last twelve months.

After such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Chinasoft International as a stock to avoid entirely with its 16.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Chinasoft International certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Chinasoft International?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 30% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 36% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 18% per annum during the coming three years according to the twelve analysts following the company. With the market only predicted to deliver 12% per year, the company is positioned for a stronger earnings result.

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.

The Final Word

Shares in Chinasoft International have built up some good momentum lately, which has really inflated its P/E. 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.

As we suspected, our examination of Chinasoft International's 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. It's hard to see the share price falling strongly in the near future under these circumstances.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Chinasoft International with six simple checks will allow you to discover any risks that could be an issue.

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.