Zhejiang Huilong New Materials Co.,Ltd. (SZSE:301057) shareholders would be excited to see that the share price has had a great month, posting a 38% gain and recovering from prior weakness. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Following the firm bounce in price, Zhejiang Huilong New MaterialsLtd's price-to-earnings (or "P/E") ratio of 36.5x 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 30x and even P/E's below 18x 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.

As an illustration, earnings have deteriorated at Zhejiang Huilong New MaterialsLtd over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Zhejiang Huilong New MaterialsLtd

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 Zhejiang Huilong New MaterialsLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 24% in aggregate from three years ago, thanks to the earlier period of growth. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that Zhejiang Huilong New MaterialsLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Zhejiang Huilong New MaterialsLtd's P/E

The large bounce in Zhejiang Huilong New MaterialsLtd's shares has lifted the company's P/E to a fairly high level. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Zhejiang Huilong New MaterialsLtd revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Zhejiang Huilong New MaterialsLtd you should be aware of, and 1 of them is significant.

Of course, you might also be able to find a better stock than Zhejiang Huilong New MaterialsLtd. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

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