Ausnutria Dairy Corporation Ltd (HKG:1717) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 18% in the last twelve months.

After such a large jump in price, Ausnutria Dairy's price-to-earnings (or "P/E") ratio of 28x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x 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.

While the market has experienced earnings growth lately, Ausnutria Dairy's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Ausnutria Dairy

Keen to find out how analysts think Ausnutria Dairy's future stacks up against the industry? In that case, our free report is a great place to start.

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 Ausnutria Dairy's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 31%. As a result, earnings from three years ago have also fallen 89% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 51% per annum as estimated by the five analysts watching the company. With the market only predicted to deliver 12% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Ausnutria Dairy'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.

The Final Word

Shares in Ausnutria Dairy 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.

We've established that Ausnutria Dairy maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It is also worth noting that we have found 1 warning sign for Ausnutria Dairy that you need to take into consideration.

You might be able to find a better investment than Ausnutria Dairy. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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