Despite an already strong run, Shanghai Pret Composites Co., Ltd. (SZSE:002324) shares have been powering on, with a gain of 27% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 12% over that time.

Following the firm bounce in price, Shanghai Pret Composites' price-to-earnings (or "P/E") ratio of 46.5x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 37x and even P/E's below 21x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings that are retreating more than the market's of late, Shanghai Pret Composites has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shanghai Pret Composites?

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

Retrospectively, the last year delivered a frustrating 42% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 123% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next year should generate growth of 48% as estimated by the dual analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 38%, which is noticeably less attractive.

In light of this, it's understandable that Shanghai Pret Composites' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

Shanghai Pret Composites shares have received a push in the right direction, but its P/E is elevated too. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Shanghai Pret Composites' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Shanghai Pret Composites (at least 1 which makes us a bit uncomfortable), and understanding them should be part of your investment process.

You might be able to find a better investment than Shanghai Pret Composites. 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.