Gansu Longshenrongfa Pharmaceutical Industry CO.,LTD (SZSE:300534) shareholders have had their patience rewarded with a 30% share price jump in the last month. Notwithstanding the latest gain, the annual share price return of 8.9% isn't as impressive.

Since its price has surged higher, Gansu Longshenrongfa Pharmaceutical IndustryLTD may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 63.8x, since almost half of all companies in China have P/E ratios under 36x and even P/E's lower than 21x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Gansu Longshenrongfa Pharmaceutical IndustryLTD certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Gansu Longshenrongfa Pharmaceutical IndustryLTD

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Gansu Longshenrongfa Pharmaceutical IndustryLTD's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 275%. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 45% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Gansu Longshenrongfa Pharmaceutical IndustryLTD is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates 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 Final Word

Gansu Longshenrongfa Pharmaceutical IndustryLTD's P/E is flying high just like its stock has during the last month. 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.

Our examination of Gansu Longshenrongfa Pharmaceutical IndustryLTD revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Gansu Longshenrongfa Pharmaceutical IndustryLTD, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Gansu Longshenrongfa Pharmaceutical IndustryLTD, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.