ChengDu Hi-Tech Development Co., Ltd. (SZSE:000628) shareholders would be excited to see that the share price has had a great month, posting a 34% gain and recovering from prior weakness. The annual gain comes to 203% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, ChengDu Hi-Tech Development may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 52.6x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, ChengDu Hi-Tech Development has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For ChengDu Hi-Tech Development?

The only time you'd be truly comfortable seeing a P/E as steep as ChengDu Hi-Tech Development's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 48%. EPS has also lifted 21% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that ChengDu Hi-Tech Development's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates 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 recent growth rates.

What We Can Learn From ChengDu Hi-Tech Development's P/E?

ChengDu Hi-Tech Development's P/E is flying high just like its stock has during the last month. 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.

We've established that ChengDu Hi-Tech Development currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for ChengDu Hi-Tech Development you should be aware of, and 2 of them make us uncomfortable.

You might be able to find a better investment than ChengDu Hi-Tech Development. 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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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.