With a median price-to-earnings (or "P/E") ratio of close to 32x in China, you could be forgiven for feeling indifferent about Yifeng Pharmacy Chain Co., Ltd.'s (SHSE:603939) P/E ratio of 31.6x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Yifeng Pharmacy Chain certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Yifeng Pharmacy Chain's is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a worthy increase of 10%. The latest three year period has also seen an excellent 77% overall rise in EPS, aided somewhat 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 three years should generate growth of 24% per annum as estimated by the analysts watching the company. With the market predicted to deliver 26% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's understandable that Yifeng Pharmacy Chain's P/E sits in line with the majority of other companies. It seems most investors are expecting to see average future growth and are only willing to pay a moderate amount for the stock.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Yifeng Pharmacy Chain's analyst forecasts revealed that its market-matching earnings outlook is contributing to its current P/E. At this stage investors feel the potential for an improvement or deterioration in earnings isn't great enough to justify a high or low P/E ratio. Unless these conditions change, they will continue to support the share price at these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Yifeng Pharmacy Chain, and understanding should be part of your investment process.

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.