With a price-to-earnings (or "P/E") ratio of 76.5x Shanghai Sanyou Medical Co., Ltd (SHSE:688085) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 16x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Shanghai Sanyou Medical could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shanghai Sanyou Medical?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Shanghai Sanyou Medical's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 69%. The last three years don't look nice either as the company has shrunk EPS by 58% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 59% per annum over the next three years. That's shaping up to be materially higher than the 24% each year growth forecast for the broader market.

With this information, we can see why Shanghai Sanyou Medical is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

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.

We've established that Shanghai Sanyou Medical maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Shanghai Sanyou Medical you should know about.

Of course, you might also be able to find a better stock than Shanghai Sanyou Medical. 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