When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Shengda Resources Co.,Ltd. (SZSE:000603) as a stock to avoid entirely with its 64.5x P/E ratio. 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.

While the market has experienced earnings growth lately, Shengda ResourcesLtd'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. 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?

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

Retrospectively, the last year delivered a frustrating 65% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 64% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 93% each year during the coming three years according to the dual analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 25% per annum, which is noticeably less attractive.

With this information, we can see why Shengda ResourcesLtd is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

As we suspected, our examination of Shengda ResourcesLtd's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Before you settle on your opinion, we've discovered 2 warning signs for Shengda ResourcesLtd that you should be aware of.

Of course, you might also be able to find a better stock than Shengda ResourcesLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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