China Longyuan Power Group Corporation Limited's (HKG:916) price-to-earnings (or "P/E") ratio of 17.3x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 8x and even P/E's below 4x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings that are retreating more than the market's of late, China Longyuan Power Group 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for China Longyuan Power Group

How Is China Longyuan Power Group's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as China Longyuan Power Group's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 13% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 39% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 21% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 14% each year, which is noticeably less attractive.

In light of this, it's understandable that China Longyuan Power Group'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.

What We Can Learn From China Longyuan Power Group's P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of China Longyuan Power Group'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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for China Longyuan Power Group that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).

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.