Shenzhen Jufei Optoelectronics Co., Ltd. (SZSE:300303) shareholders have had their patience rewarded with a 45% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 32%.

Following the firm bounce in price, Shenzhen Jufei Optoelectronics' price-to-earnings (or "P/E") ratio of 37.1x 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 33x and even P/E's below 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

The earnings growth achieved at Shenzhen Jufei Optoelectronics over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Shenzhen Jufei Optoelectronics would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 27%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 15% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 37% 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 Shenzhen Jufei Optoelectronics is trading at a P/E higher than 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 very 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

The large bounce in Shenzhen Jufei Optoelectronics' shares has lifted the company's P/E to a fairly high level. 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 Shenzhen Jufei Optoelectronics currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 3 warning signs we've spotted with Shenzhen Jufei Optoelectronics (including 1 which is a bit unpleasant).

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.