Despite an already strong run, Dongfang Electric Corporation Limited (HKG:1072) shares have been powering on, with a gain of 57% in the last thirty days. The last month tops off a massive increase of 109% in the last year.

After such a large jump in price, Dongfang Electric may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 20.9x, since almost half of all companies in Hong Kong have P/E ratios under 11x and even P/E's lower than 7x 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 so lofty.

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Dongfang Electric hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.

Check out our latest analysis for Dongfang Electric

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Dongfang Electric.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Dongfang Electric's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 7.7%. Regardless, EPS has managed to lift by a handy 14% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 15% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is not materially different.

With this information, we find it interesting that Dongfang Electric is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for 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 Dongfang Electric's P/E rushing to great heights as well. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Dongfang Electric currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Dongfang Electric that you should be aware of.

If you're unsure about the strength of Dongfang Electric's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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.