Konfoong Materials International Co., Ltd's (SZSE:300666) price-to-earnings (or "P/E") ratio of 50.3x 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 32x and even P/E's below 19x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Konfoong Materials International has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. 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 Konfoong Materials International's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 46%. The latest three year period has also seen an excellent 126% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 34% over the next year. That's shaping up to be materially lower than the 38% growth forecast for the broader market.

With this information, we find it concerning that Konfoong Materials International is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

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.

We've established that Konfoong Materials International currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Konfoong Materials International (at least 1 which doesn't sit too well with us), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Konfoong Materials International, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.