Explosive Co., Ltd.'s (SZSE:002096) price-to-earnings (or "P/E") ratio of 66.2x might make it look like a strong 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 19x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Explosive could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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

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

Retrospectively, the last year delivered a frustrating 45% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 159% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 108% during the coming year according to the dual analysts following the company. With the market only predicted to deliver 36%, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Explosive'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.

What We Can Learn From Explosive's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Explosive maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 2 warning signs for Explosive you should be aware of.

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

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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.