The Shandong Homey Aquatic Development Co.,Ltd. (SHSE:600467) share price has done very well over the last month, posting an excellent gain of 30%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 19% in the last twelve months.

After such a large jump in price, Shandong Homey Aquatic DevelopmentLtd may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 61.5x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x 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.

As an illustration, earnings have deteriorated at Shandong Homey Aquatic DevelopmentLtd over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, 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 Shandong Homey Aquatic DevelopmentLtd?

In order to justify its P/E ratio, Shandong Homey Aquatic DevelopmentLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 15% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 27% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Shandong Homey Aquatic DevelopmentLtd's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

Shares in Shandong Homey Aquatic DevelopmentLtd have built up some good momentum lately, which has really inflated its P/E. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shandong Homey Aquatic DevelopmentLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shandong Homey Aquatic DevelopmentLtd, and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Shandong Homey Aquatic DevelopmentLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.