Guangdong Zhongsheng Pharmaceutical Co., Ltd. (SZSE:002317) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 17% in the last twelve months.

After such a large jump in price, Guangdong Zhongsheng Pharmaceutical's price-to-earnings (or "P/E") ratio of 40.5x might 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 30x and even P/E's below 18x 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.

Recent times have been advantageous for Guangdong Zhongsheng Pharmaceutical as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 60%. The latest three year period has also seen an excellent 32% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next year should generate growth of 5.7% as estimated by the sole analyst watching the company. Meanwhile, the rest of the market is forecast to expand by 39%, which is noticeably more attractive.

In light of this, it's alarming that Guangdong Zhongsheng Pharmaceutical's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Guangdong Zhongsheng Pharmaceutical's P/E

The large bounce in Guangdong Zhongsheng Pharmaceutical's shares has lifted the company's P/E to a fairly high level. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Guangdong Zhongsheng Pharmaceutical currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Guangdong Zhongsheng Pharmaceutical (1 is potentially serious!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Guangdong Zhongsheng Pharmaceutical. 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.