With a price-to-earnings (or "P/E") ratio of 52.6x Shanghai Medicilon Inc. (SHSE:688202) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 35x and even P/E's lower than 20x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Recent times haven't been advantageous for Shanghai Medicilon as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Shanghai Medicilon

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Shanghai Medicilon's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 55% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 62% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Looking ahead now, EPS is anticipated to climb by 16% during the coming year according to the only analyst following the company. That's shaping up to be materially lower than the 43% growth forecast for the broader market.

With this information, we find it concerning that Shanghai Medicilon is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

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 Shanghai Medicilon's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 4 warning signs we've spotted with Shanghai Medicilon (including 1 which shouldn't be ignored).

If you're unsure about the strength of Shanghai Medicilon's 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.