Hanshang Group Co., Ltd. (SHSE:600774) shares have retraced a considerable 25% in the last month, reversing a fair amount of their solid recent performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 39% share price drop.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 28x, you may still consider Hanshang Group as a stock to avoid entirely with its 45.5x 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.

For example, consider that Hanshang Group's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Hanshang Group?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. As a result, earnings from three years ago have also fallen 59% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hanshang Group is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Hanshang Group's P/E?

Hanshang Group's shares may have retreated, but its P/E is still flying high. 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.

We've established that Hanshang Group currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It is also worth noting that we have found 3 warning signs for Hanshang Group (1 is significant!) that you need to take into consideration.

If these risks are making you reconsider your opinion on Hanshang Group, 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.

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