When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 35x, you may consider Hubei Heyuan Gas Co.,Ltd. (SZSE:002971) as a stock to potentially avoid with its 51.8x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Hubei Heyuan GasLtd's financial performance has been pretty ordinary lately as earnings growth is non-existent. One possibility is that the P/E is high because investors think the benign earnings growth will improve to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for Hubei Heyuan GasLtd

Is There Enough Growth For Hubei Heyuan GasLtd?

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

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 1.1% decline in EPS over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 43% shows it's an unpleasant look.

With this information, we find it concerning that Hubei Heyuan GasLtd 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.

The Bottom Line On Hubei Heyuan GasLtd's P/E

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 Hubei Heyuan GasLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Hubei Heyuan GasLtd (of which 2 are potentially serious!) you should know about.

Of course, you might also be able to find a better stock than Hubei Heyuan GasLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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