Those holding Shenzhen Zhaowei Machinery & Electronics Co., Ltd. (SZSE:003021) shares would be relieved that the share price has rebounded 29% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, despite the strong performance over the last month, the full year gain of 5.5% isn't as attractive.

Since its price has surged higher, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Shenzhen Zhaowei Machinery & Electronics as a stock to avoid entirely with its 65.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Shenzhen Zhaowei Machinery & Electronics certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Shenzhen Zhaowei Machinery & Electronics' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 47% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 57% 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.

Turning to the outlook, the next year should generate growth of 33% as estimated by the three analysts watching the company. With the market predicted to deliver 42% growth , the company is positioned for a weaker earnings result.

With this information, we find it concerning that Shenzhen Zhaowei Machinery & Electronics is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

The strong share price surge has got Shenzhen Zhaowei Machinery & Electronics' P/E rushing to great heights as well. 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.

We've established that Shenzhen Zhaowei Machinery & Electronics currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places 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 2 warning signs for Shenzhen Zhaowei Machinery & Electronics that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.