When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Shenzhen YHLO Biotech Co., Ltd. (SHSE:688575) as a stock to potentially avoid with its 40.3x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Shenzhen YHLO Biotech has been struggling lately as its earnings have declined faster 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.

Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 65% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 52% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 40% as estimated by the two analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 41%, which is not materially different.

With this information, we find it interesting that Shenzhen YHLO Biotech is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Shenzhen YHLO Biotech's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Shenzhen YHLO Biotech that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.