DongHua Testing Technology Co. , Ltd. (SZSE:300354) shares have continued their recent momentum with a 28% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 5.9% in the last twelve months.

Following the firm bounce in price, DongHua Testing Technology may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 58.7x, since almost half of all companies in China have P/E ratios under 37x and even P/E's lower than 21x 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.

With earnings that are retreating more than the market's of late, DongHua Testing Technology has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

In order to justify its P/E ratio, DongHua Testing Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 30%. Even so, admirably EPS has lifted 30% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next year should generate growth of 128% as estimated by the three analysts watching the company. That's shaping up to be materially higher than the 38% growth forecast for the broader market.

With this information, we can see why DongHua Testing Technology 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.

The Key Takeaway

The strong share price surge has got DongHua Testing Technology's P/E rushing to great heights as well. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of DongHua Testing Technology's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for DongHua Testing Technology with six simple checks on some of these key factors.

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.