When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Yantai Dongcheng Pharmaceutical Group Co.,Ltd. (SZSE:002675) as a stock to avoid entirely with its 48.6x 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.

While the market has experienced earnings growth lately, Yantai Dongcheng Pharmaceutical GroupLtd's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 47% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 24% per annum during the coming three years according to the five analysts following the company. Meanwhile, the rest of the market is forecast to expand by 25% per year, which is not materially different.

With this information, we find it interesting that Yantai Dongcheng Pharmaceutical GroupLtd is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Yantai Dongcheng Pharmaceutical GroupLtd'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.

Our examination of Yantai Dongcheng Pharmaceutical GroupLtd's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Yantai Dongcheng Pharmaceutical GroupLtd you should know about.

You might be able to find a better investment than Yantai Dongcheng Pharmaceutical GroupLtd. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com