Hootech Inc. (SZSE:301026) shareholders have had their patience rewarded with a 28% share price jump in the last month. Unfortunately, despite the strong performance over the last month, the full year gain of 8.1% isn't as attractive.

Although its price has surged higher, there still wouldn't be many who think Hootech's price-to-earnings (or "P/E") ratio of 27.1x is worth a mention when the median P/E in China is similar at about 30x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Earnings have risen firmly for Hootech recently, which is pleasing to see. It might be that many expect the respectable earnings performance to wane, which has kept the P/E from rising. If that doesn't eventuate, then existing shareholders probably aren't too pessimistic about the future direction of the share price.

Does Growth Match The P/E?

In order to justify its P/E ratio, Hootech would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a decent 8.5% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen an unpleasant 61% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hootech is trading at a fairly similar P/E to the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Hootech's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Hootech currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 4 warning signs for Hootech (1 is a bit unpleasant!) that we have uncovered.

You might be able to find a better investment than Hootech. 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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