When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider Shanghai Stonehill Technology Co., Ltd. (SZSE:002195) as a stock to avoid entirely with its 78x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Shanghai Stonehill Technology's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Shanghai Stonehill Technology

Is There Enough Growth For Shanghai Stonehill Technology?

In order to justify its P/E ratio, Shanghai Stonehill Technology would need to produce outstanding growth well in excess of 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 43%. As a result, earnings from three years ago have also fallen 32% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's an unpleasant look.

With this information, we find it concerning that Shanghai Stonehill Technology is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Shanghai Stonehill Technology's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Shanghai Stonehill Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. 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.

Having said that, be aware Shanghai Stonehill Technology is showing 5 warning signs in our investment analysis, and 1 of those is potentially serious.

You might be able to find a better investment than Shanghai Stonehill Technology. 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.