New East New Materials Co., Ltd's (SHSE:603110) Shares Climb 30% But Its Business Is Yet to Catch Up

Despite an already strong run, New East New Materials Co., Ltd (SHSE:603110) shares have been powering on, with a gain of 30% in the last thirty days. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 38% in the last twelve months.

Since its price has surged higher, New East New Materials' price-to-earnings (or "P/E") ratio of 77.2x 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 34x and even P/E's below 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's exceedingly strong of late, New East New Materials has been doing very well. 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.

Check out our latest analysis for New East New Materials

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Is There Enough Growth For New East New Materials?

In order to justify its P/E ratio, New East New Materials would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 177%. However, this wasn't enough as the latest three year period has seen a very unpleasant 27% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 39% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that New East New Materials' 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 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. 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 New East New Materials currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for New East New Materials that you need to be mindful of.

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.

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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.