When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may consider Shandong Sito Bio-technology Co., Ltd. (SZSE:300583) as a stock to avoid entirely with its 45.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Shandong Sito Bio-technology has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable 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.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Shandong Sito Bio-technology would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 41% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Shandong Sito Bio-technology's P/E sits above the majority of other companies. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Shandong Sito Bio-technology currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Shandong Sito Bio-technology you should be aware of, and 1 of them doesn't sit too well with us.

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.