LifeTech Scientific Corporation (HKG:1302) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 48% share price drop.

Even after such a large drop in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may still consider LifeTech Scientific as a stock to avoid entirely with its 21.7x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

LifeTech Scientific certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.

View our latest analysis for LifeTech Scientific

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

LifeTech Scientific's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 9.8% last year. The latest three year period has also seen an excellent 117% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the one analyst covering the company suggest earnings should grow by 17% over the next year. That's shaping up to be materially lower than the 21% growth forecast for the broader market.

In light of this, it's alarming that LifeTech Scientific's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

LifeTech Scientific's shares may have retreated, but its P/E is still flying high. 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.

We've established that LifeTech Scientific currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for LifeTech Scientific with six simple checks will allow you to discover any risks that could be an issue.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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.