With a price-to-earnings (or "P/E") ratio of 33x Shanghai Zhenhua Heavy Industries Co., Ltd. (SHSE:600320) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 16x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Shanghai Zhenhua Heavy Industries has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shanghai Zhenhua Heavy Industries?

In order to justify its P/E ratio, Shanghai Zhenhua Heavy Industries would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a worthy increase of 4.9%. The latest three year period has also seen a 11% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the one analyst covering the company suggest earnings should grow by 38% per annum over the next three years. With the market only predicted to deliver 25% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Shanghai Zhenhua Heavy Industries' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

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.

As we suspected, our examination of Shanghai Zhenhua Heavy Industries' 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Shanghai Zhenhua Heavy Industries (at least 1 which doesn't sit too well with us), and understanding them should be part of your investment process.

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

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