Nanjing Develop Advanced Manufacturing Co., Ltd. (SHSE:688377) shares have continued their recent momentum with a 32% gain in the last month alone. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 24% in the last twelve months.

Since its price has surged higher, Nanjing Develop Advanced Manufacturing may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 45.3x, since almost half of all companies in China have P/E ratios under 35x and even P/E's lower than 20x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings that are retreating more than the market's of late, Nanjing Develop Advanced Manufacturing 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. If not, then existing shareholders may be very nervous about the viability of the share price.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Nanjing Develop Advanced Manufacturing's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 44% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 118% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Shifting to the future, estimates from the only analyst covering the company suggest earnings should grow by 89% over the next year. With the market only predicted to deliver 38%, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Nanjing Develop Advanced Manufacturing's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

The large bounce in Nanjing Develop Advanced Manufacturing's shares has lifted the company's P/E to a fairly high level. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Nanjing Develop Advanced Manufacturing'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.

You always need to take note of risks, for example - Nanjing Develop Advanced Manufacturing has 2 warning signs we think you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.