With a price-to-earnings (or "P/E") ratio of 16.6x China Tower Corporation Limited (HKG:788) may be sending bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 11x and even P/E's lower than 6x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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China Tower certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as China Tower's is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 9.4% last year. This was backed up an excellent period prior to see EPS up by 40% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 28% per year as estimated by the twelve analysts watching the company. That's shaping up to be materially higher than the 15% per year growth forecast for the broader market.

With this information, we can see why China Tower is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

As we suspected, our examination of China Tower's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

It is also worth noting that we have found 2 warning signs for China Tower that you need to take into consideration.

Of course, you might also be able to find a better stock than China Tower. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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