Despite an already strong run, Chongqing Zongshen Power Machinery Co.,Ltd (SZSE:001696) shares have been powering on, with a gain of 33% in the last thirty days. The last 30 days bring the annual gain to a very sharp 79%.

After such a large jump in price, Chongqing Zongshen Power MachineryLtd may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 36.2x, since almost half of all companies in China have P/E ratios under 31x and even P/E's lower than 19x are not unusual. 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.

For instance, Chongqing Zongshen Power MachineryLtd's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Chongqing Zongshen Power MachineryLtd's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 6.4% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 40% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's an unpleasant look.

In light of this, it's alarming that Chongqing Zongshen Power MachineryLtd's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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

The large bounce in Chongqing Zongshen Power MachineryLtd's shares has lifted the company's P/E to a fairly high level. 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.

Our examination of Chongqing Zongshen Power MachineryLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Chongqing Zongshen Power MachineryLtd (1 is concerning!) that you need to take into consideration.

If you're unsure about the strength of Chongqing Zongshen Power MachineryLtd'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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