New East New Materials Co., Ltd's (SHSE:603110) 30% Share Price Surge Not Quite Adding Up

New East New Materials Co., Ltd (SHSE:603110) shares have continued their recent momentum with a 30% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 38% over that time.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider New East New Materials as a stock to avoid entirely with its 77.2x 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.

Recent times have been quite advantageous for New East New Materials as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be 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.

View our latest analysis for New East New Materials

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on New East New Materials' earnings, revenue and cash flow.

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 New East New Materials' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 177%. Still, incredibly EPS has fallen 27% in total from three years ago, which is quite disappointing. 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.

With this information, we find it concerning that New East New Materials is trading at a P/E higher than the market. 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 Bottom Line On New East New Materials' P/E

Shares in New East New Materials have built up some good momentum lately, which has really inflated its 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.

Our examination of New East New Materials 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. 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.

You always need to take note of risks, for example - New East New Materials has 2 warning signs we think you should be aware of.

If you're unsure about the strength of New East New Materials' 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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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.