Hainan Huluwa Pharmaceutical Group Co., Ltd. (SHSE:605199) shareholders that were waiting for something to happen have been dealt a blow with a 25% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 31% share price drop.

Even after such a large drop in price, Hainan Huluwa Pharmaceutical Group's price-to-earnings (or "P/E") ratio of 49.8x might still make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 26x and even P/E's below 16x are quite common. 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.

Hainan Huluwa Pharmaceutical Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Hainan Huluwa Pharmaceutical Group?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Hainan Huluwa Pharmaceutical Group's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 31%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 43% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 42% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hainan Huluwa Pharmaceutical Group 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. 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

Even after such a strong price drop, Hainan Huluwa Pharmaceutical Group's P/E still exceeds the rest of the market significantly. 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.

Our examination of Hainan Huluwa Pharmaceutical Group 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Hainan Huluwa Pharmaceutical Group that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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