When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider ChengDu ShengNuo Biotec Co.,Ltd. (SHSE:688117) as a stock to potentially avoid with its 33.4x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for ChengDu ShengNuo BiotecLtd as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, ChengDu ShengNuo BiotecLtd would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 12% last year. Still, lamentably EPS has fallen 11% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 37% per annum during the coming three years according to the dual analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 25% per annum, which is noticeably less attractive.

With this information, we can see why ChengDu ShengNuo BiotecLtd is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that ChengDu ShengNuo BiotecLtd maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with ChengDu ShengNuo BiotecLtd (at least 1 which is significant), and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than ChengDu ShengNuo BiotecLtd. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com