When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may consider Shanghai Chinafortune Co., Ltd. (SHSE:600621) as a stock to potentially avoid with its 35.9x P/E ratio. 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.

With earnings growth that's superior to most other companies of late, Shanghai Chinafortune has been doing relatively well. 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.

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

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

If we review the last year of earnings growth, the company posted a worthy increase of 6.8%. Still, lamentably EPS has fallen 46% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 2.3% per year during the coming three years according to the lone analyst following the company. Meanwhile, the rest of the market is forecast to expand by 24% per year, which is noticeably more attractive.

With this information, we find it concerning that Shanghai Chinafortune is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Shanghai Chinafortune's P/E

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.

We've established that Shanghai Chinafortune currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware Shanghai Chinafortune is showing 2 warning signs in our investment analysis, and 1 of those is significant.

You might be able to find a better investment than Shanghai Chinafortune. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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