Shanghai Shentong Metro Co.,Ltd. (SHSE:600834) shareholders would be excited to see that the share price has had a great month, posting a 42% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 9.0% isn't as impressive.

Following the firm bounce in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may consider Shanghai Shentong MetroLtd as a stock to avoid entirely with its 67.5x 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 instance, Shanghai Shentong MetroLtd's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Shanghai Shentong MetroLtd?

Shanghai Shentong MetroLtd's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 13%. As a result, earnings from three years ago have also fallen 2.7% 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 35% 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 Shanghai Shentong MetroLtd 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Shanghai Shentong MetroLtd's P/E is flying high just like its stock has during the last month. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Shanghai Shentong MetroLtd 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Shanghai Shentong MetroLtd with six simple checks on some of these key factors.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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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