To the annoyance of some shareholders, Hunan Heshun Petroleum Co.,Ltd. (SHSE:603353) shares are down a considerable 36% in the last month, which continues a horrid run for the company. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 22% share price drop.

Even after such a large drop in price, Hunan Heshun PetroleumLtd's price-to-earnings (or "P/E") ratio of 38.2x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 26x and even P/E's below 16x are quite common. 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.

As an illustration, earnings have deteriorated at Hunan Heshun PetroleumLtd over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Hunan Heshun PetroleumLtd?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 30%. This means it has also seen a slide in earnings over the longer-term as EPS is down 64% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 41% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hunan Heshun PetroleumLtd 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.

What We Can Learn From Hunan Heshun PetroleumLtd's P/E?

Hunan Heshun PetroleumLtd's P/E hasn't come down all the way after its stock plunged. 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 Hunan Heshun PetroleumLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

You should always think about risks. Case in point, we've spotted 4 warning signs for Hunan Heshun PetroleumLtd you should be aware of, and 1 of them is a bit concerning.

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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