With a price-to-earnings (or "P/E") ratio of 12.4x Dongjiang Environmental Company Limited (HKG:895) may be sending bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 8x and even P/E's lower than 4x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Dongjiang Environmental could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for Dongjiang Environmental

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

The only time you'd be truly comfortable seeing a P/E as high as Dongjiang Environmental's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 50% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 57% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 20% per year as estimated by the twin analysts watching the company. That's shaping up to be materially higher than the 15% per annum growth forecast for the broader market.

In light of this, it's understandable that Dongjiang Environmental'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 Bottom Line On Dongjiang Environmental's P/E

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Dongjiang Environmental'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. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Dongjiang Environmental (of which 1 is a bit unpleasant!) you should know about.

You might be able to find a better investment than Dongjiang Environmental. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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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.