Despite an already strong run, Fujian Zhangzhou Development Co.,LTD. (SZSE:000753) shares have been powering on, with a gain of 29% in the last thirty days. Unfortunately, despite the strong performance over the last month, the full year gain of 7.4% isn't as attractive.

After such a large jump in price, Fujian Zhangzhou DevelopmentLTD's price-to-earnings (or "P/E") ratio of 59.2x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 35x 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 highly elevated P/E.

With earnings growth that's exceedingly strong of late, Fujian Zhangzhou DevelopmentLTD 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. If not, then existing shareholders might 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, Fujian Zhangzhou DevelopmentLTD would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 78% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 43% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's an unpleasant look.

In light of this, it's alarming that Fujian Zhangzhou DevelopmentLTD's 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

Shares in Fujian Zhangzhou DevelopmentLTD have built up some good momentum lately, which has really inflated its P/E. 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.

Our examination of Fujian Zhangzhou DevelopmentLTD revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Fujian Zhangzhou DevelopmentLTD (at least 2 which are significant), and understanding them should be part of your investment process.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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