Zhejiang Extek Technology Co., Ltd.'s (SZSE:301399) price-to-earnings (or "P/E") ratio of 50.2x 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 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 elevated P/E.

For instance, Zhejiang Extek Technology's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, 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.

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

The only time you'd be truly comfortable seeing a P/E as high as Zhejiang Extek Technology's is when the company's growth is on track to outshine the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 48%. The last three years don't look nice either as the company has shrunk EPS by 39% in aggregate. 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 38% shows it's an unpleasant look.

In light of this, it's alarming that Zhejiang Extek Technology'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

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.

We've established that Zhejiang Extek Technology 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.

You need to take note of risks, for example - Zhejiang Extek Technology has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

You might be able to find a better investment than Zhejiang Extek Technology. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.