The Shang Gong Group Co., Ltd. (SHSE:600843) share price has fared very poorly over the last month, falling by a substantial 30%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 24% in that time.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may still consider Shang Gong Group as a stock to potentially avoid with its 36.6x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Earnings have risen firmly for Shang Gong Group recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shang Gong Group?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 22% last year. The strong recent performance means it was also able to grow EPS by 31% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 41% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Shang Gong Group's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From Shang Gong Group's P/E?

There's still some solid strength behind Shang Gong Group's P/E, if not its share price lately. 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.

We've established that Shang Gong Group currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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.

Having said that, be aware Shang Gong Group is showing 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.