Nanfang Communication Holdings Limited (HKG:1617) shares have had a really impressive month, gaining 55% after a shaky period beforehand. Looking further back, the 12% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, Nanfang Communication Holdings may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 20.5x, since almost half of all companies in Hong Kong have P/E ratios under 10x and even P/E's lower than 6x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Nanfang Communication Holdings' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Nanfang Communication Holdings would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 38%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 22% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Nanfang Communication Holdings' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

The Final Word

Shares in Nanfang Communication Holdings 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.

We've established that Nanfang Communication Holdings 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.

Having said that, be aware Nanfang Communication Holdings is showing 4 warning signs in our investment analysis, and 1 of those doesn't sit too well with us.

If these risks are making you reconsider your opinion on Nanfang Communication Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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