Shenzhen Institute of Building Research Co., Ltd. (SZSE:300675) shareholders have had their patience rewarded with a 43% share price jump in the last month. Notwithstanding the latest gain, the annual share price return of 8.4% isn't as impressive.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider Shenzhen Institute of Building Research as a stock to avoid entirely with its 60.5x 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.

Shenzhen Institute of Building Research has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Shenzhen Institute of Building Research's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 11% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 4.4% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings should grow by 22% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 19% per annum, which is noticeably less attractive.

With this information, we can see why Shenzhen Institute of Building Research is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Shenzhen Institute of Building Research's P/E?

Shenzhen Institute of Building Research's P/E is flying high just like its stock has during the last month. 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 Shenzhen Institute of Building Research'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. Unless these conditions change, they will continue to provide strong support to the share price.

It is also worth noting that we have found 3 warning signs for Shenzhen Institute of Building Research (2 make us uncomfortable!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Shenzhen Institute of Building Research. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.