Hengxin Technology Ltd. (HKG:1085) shareholders have had their patience rewarded with a 25% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 52% in the last year.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider Hengxin Technology as a stock to avoid entirely with its 19.6x 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 growth that's exceedingly strong of late, Hengxin Technology has been doing very well. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Hengxin Technology

Does Growth Match The High P/E?

Hengxin Technology'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.

Retrospectively, the last year delivered an exceptional 66% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 29% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 20% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Hengxin Technology's P/E sits above the majority of other companies. 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 Final Word

Shares in Hengxin Technology 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.

We've established that Hengxin Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

Before you take the next step, you should know about the 1 warning sign for Hengxin Technology that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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.