When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider Shenwan Hongyuan Group Co., Ltd. (SZSE:000166) as a stock to potentially avoid with its 38.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Shenwan Hongyuan Group has been struggling lately as its earnings have declined faster than most other companies. 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.

See our latest analysis for Shenwan Hongyuan Group

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 Shenwan Hongyuan Group's is when the company's growth is on track to outshine the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 54%. As a result, earnings from three years ago have also fallen 62% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next year should generate growth of 173% as estimated by the four analysts watching the company. With the market only predicted to deliver 44%, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Shenwan Hongyuan Group's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

We've established that Shenwan Hongyuan Group 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. 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 2 warning signs with Shenwan Hongyuan Group, and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.