Gansu Longshenrongfa Pharmaceutical Industry CO.,LTD (SZSE:300534) shareholders won't be pleased to see that the share price has had a very rough month, dropping 32% and undoing the prior period's positive performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 23% in that time.

Although its price has dipped substantially, Gansu Longshenrongfa Pharmaceutical IndustryLTD may still be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 39.7x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 17x 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.

With earnings growth that's exceedingly strong of late, Gansu Longshenrongfa Pharmaceutical IndustryLTD has been doing very well. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Gansu Longshenrongfa Pharmaceutical IndustryLTD?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 275% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the market, which is predicted to deliver 41% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Gansu Longshenrongfa Pharmaceutical IndustryLTD is trading at a P/E higher than the market. 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 Key Takeaway

Despite the recent share price weakness, Gansu Longshenrongfa Pharmaceutical IndustryLTD's P/E remains higher than most other companies. 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. When we see weak earnings with slower than market growth, 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.

Having said that, be aware Gansu Longshenrongfa Pharmaceutical IndustryLTD is showing 2 warning signs in our investment analysis, and 1 of those is a bit concerning.

Of course, you might also be able to find a better stock than Gansu Longshenrongfa Pharmaceutical IndustryLTD. 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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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.