Shang Gong Group Co., Ltd. (SHSE:600843) shares have had a really impressive month, gaining 32% after a shaky period beforehand. Looking further back, the 20% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, Shang Gong Group may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 57.4x, 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Shang Gong Group has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable earnings growth will be 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.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Shang Gong Group would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. Pleasingly, EPS has also lifted 31% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Shang Gong Group's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From Shang Gong Group's P/E?

The strong share price surge has got Shang Gong Group's P/E rushing to great heights as well. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Shang Gong Group revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

Before you settle on your opinion, we've discovered 4 warning signs for Shang Gong Group (1 doesn't sit too well with us!) that you should be aware of.

If these risks are making you reconsider your opinion on Shang Gong Group, 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.