With a price-to-earnings (or "P/E") ratio of 32.5x Sichuan Development Lomon Co.,Ltd. (SZSE:002312) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x 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.

While the market has experienced earnings growth lately, Sichuan Development LomonLtd's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Does Growth Match The High P/E?

Sichuan Development LomonLtd's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 63%. The last three years don't look nice either as the company has shrunk EPS by 65% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 35% per year during the coming three years according to the two analysts following the company. With the market only predicted to deliver 23% per annum, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Sichuan Development LomonLtd's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Sichuan Development LomonLtd maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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 is also worth noting that we have found 2 warning signs for Sichuan Development LomonLtd that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.