Shunfa Hengneng Corporation (SZSE:000631) shares have continued their recent momentum with a 27% gain in the last month alone. 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.

Following the firm bounce in price, Shunfa Hengneng's price-to-earnings (or "P/E") ratio of 67.7x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 35x and even P/E's below 20x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shunfa Hengneng's receding earnings in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Shunfa Hengneng's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 65% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 21% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 39% 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 Shunfa Hengneng is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Bottom Line On Shunfa Hengneng's P/E

The strong share price surge has got Shunfa Hengneng's P/E rushing to great heights as well. 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.

Our examination of Shunfa Hengneng revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 3 warning signs for Shunfa Hengneng (2 are a bit unpleasant!) that we have uncovered.

If these risks are making you reconsider your opinion on Shunfa Hengneng, explore our interactive list of high quality stocks to get an idea of what else is out there.

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