With a price-to-earnings (or "P/E") ratio of 55.5x Jiangsu Hengrui Medicine Co., Ltd. (SHSE:600276) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 28x and even P/E's lower than 17x 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.

Jiangsu Hengrui Medicine certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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 Jiangsu Hengrui Medicine's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 15%. However, this wasn't enough as the latest three year period has seen an unpleasant 32% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 27% per year over the next three years. With the market only predicted to deliver 25% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Jiangsu Hengrui Medicine's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Jiangsu Hengrui Medicine's P/E?

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.

As we suspected, our examination of Jiangsu Hengrui Medicine'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. It's hard to see the share price falling strongly in the near future under these circumstances.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Jiangsu Hengrui Medicine with six simple checks.

If you're unsure about the strength of Jiangsu Hengrui Medicine's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

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