With a price-to-earnings (or "P/E") ratio of 44.5x Southchip Semiconductor Technology(Shanghai) Co., Ltd. (SHSE:688484) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 34x and even P/E's lower than 20x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Southchip Semiconductor Technology(Shanghai) certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. 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 outperform the market for P/E ratios like Southchip Semiconductor Technology(Shanghai)'s to be considered reasonable.

Retrospectively, the last year delivered an exceptional 79% gain to the company's bottom line. As a result, it also grew EPS by 17% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Looking ahead now, EPS is anticipated to climb by 32% during the coming year according to the five analysts following the company. Meanwhile, the rest of the market is forecast to expand by 39%, which is noticeably more attractive.

In light of this, it's alarming that Southchip Semiconductor Technology(Shanghai)'s P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Southchip Semiconductor Technology(Shanghai) currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Southchip Semiconductor Technology(Shanghai) with six simple checks.

If these risks are making you reconsider your opinion on Southchip Semiconductor Technology(Shanghai), 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.