The Playmates Toys Limited (HKG:869) share price has done very well over the last month, posting an excellent gain of 27%. Taking a wider view, although not as strong as the last month, the full year gain of 15% is also fairly reasonable.

Following the firm bounce in price, Playmates Toys may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 27x, since almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 4x 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.

For instance, Playmates Toys' receding earnings in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Playmates Toys

How Is Playmates Toys' Growth Trending?

In order to justify its P/E ratio, Playmates Toys would need to produce outstanding growth well in excess of 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 27%. Even so, admirably EPS has lifted 142% 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.

This is in contrast to the rest of the market, which is expected to grow by 19% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we can see why Playmates Toys is trading at such a high P/E compared to the market. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

Shares in Playmates Toys have built up some good momentum lately, which has really inflated its P/E. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Playmates Toys revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

You need to take note of risks, for example - Playmates Toys has 5 warning signs (and 1 which is significant) we think you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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.