Sichuan Furong Technology Co., Ltd. (SHSE:603327) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Although its price has surged higher, you could still be forgiven for feeling indifferent about Sichuan Furong Technology's P/E ratio of 27.6x, since the median price-to-earnings (or "P/E") ratio in China is also close to 30x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Sichuan Furong Technology has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to revert back to market averages soon, which has kept the P/E from falling. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders may be a little nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like Sichuan Furong Technology's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 23% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Looking ahead now, EPS is anticipated to climb by 35% during the coming year according to the one analyst following the company. That's shaping up to be materially lower than the 41% growth forecast for the broader market.

With this information, we find it interesting that Sichuan Furong Technology is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Key Takeaway

Sichuan Furong Technology's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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.

Our examination of Sichuan Furong Technology's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 2 warning signs for Sichuan Furong Technology (1 is a bit unpleasant!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Sichuan Furong Technology. 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.