When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider Shanghai Sinotec Co., Ltd. (SHSE:603121) as a stock to potentially avoid with its 46x 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 as high as it is.

Recent times have been quite advantageous for Shanghai Sinotec as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Shanghai Sinotec

Is There Enough Growth For Shanghai Sinotec?

The only time you'd be truly comfortable seeing a P/E as high as Shanghai Sinotec's is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 291% last year. As a result, it also grew EPS by 9.0% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Shanghai Sinotec's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates 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 Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Shanghai Sinotec currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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 2 warning signs for Shanghai Sinotec (1 makes us a bit uncomfortable!) that we have uncovered.

Of course, you might also be able to find a better stock than Shanghai Sinotec. 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.