Those holding Huizhou Desay SV Automotive Co., Ltd. (SZSE:002920) shares would be relieved that the share price has rebounded 26% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Taking a wider view, although not as strong as the last month, the full year gain of 15% is also fairly reasonable.

Since its price has surged higher, Huizhou Desay SV Automotive's price-to-earnings (or "P/E") ratio of 43.8x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 31x and even P/E's below 18x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

With earnings growth that's superior to most other companies of late, Huizhou Desay SV Automotive has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Is There Enough Growth For Huizhou Desay SV Automotive?

There's an inherent assumption that a company should outperform the market for P/E ratios like Huizhou Desay SV Automotive's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 41% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 208% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 34% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 21% per annum, which is noticeably less attractive.

In light of this, it's understandable that Huizhou Desay SV Automotive'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.

The Key Takeaway

The large bounce in Huizhou Desay SV Automotive's shares has lifted the company's P/E to a fairly high level. 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.

As we suspected, our examination of Huizhou Desay SV Automotive's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Huizhou Desay SV Automotive that you should be aware of.

If you're unsure about the strength of Huizhou Desay SV Automotive's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.