With a price-to-earnings (or "P/E") ratio of 47.4x Hangzhou Cogeneration Group Co., Ltd. (SHSE:605011) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 35x and even P/E's lower than 20x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Earnings have risen at a steady rate over the last year for Hangzhou Cogeneration Group, which is generally not a bad outcome. It might be that many expect the reasonable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Hangzhou Cogeneration Group's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 5.8%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 25% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 34% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hangzhou Cogeneration Group is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Hangzhou Cogeneration Group's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Hangzhou Cogeneration Group revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Hangzhou Cogeneration Group is showing 2 warning signs in our investment analysis, and 1 of those is a bit concerning.

If these risks are making you reconsider your opinion on Hangzhou Cogeneration Group, explore our interactive list of high quality stocks to get an idea of what else is out there.

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