Those holding Kunshan Dongwei Technology Co.,Ltd. (SHSE:688700) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 50% share price drop in the last twelve months.

Following the firm bounce in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Kunshan Dongwei TechnologyLtd as a stock to avoid entirely with its 54.5x 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.

With earnings that are retreating more than the market's of late, Kunshan Dongwei TechnologyLtd 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. If not, then existing shareholders may be very nervous about the viability of the share price.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Kunshan Dongwei TechnologyLtd's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 30%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 25% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 79% over the next year. Meanwhile, the rest of the market is forecast to only expand by 41%, which is noticeably less attractive.

With this information, we can see why Kunshan Dongwei TechnologyLtd is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Kunshan Dongwei TechnologyLtd's P/E?

Shares in Kunshan Dongwei TechnologyLtd have built up some good momentum lately, which has really inflated its P/E. 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.

As we suspected, our examination of Kunshan Dongwei TechnologyLtd'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.

Having said that, be aware Kunshan Dongwei TechnologyLtd is showing 2 warning signs in our investment analysis, you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.