Sichuan Huiyu Pharmaceutical Co., Ltd. (SHSE:688553) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 23% over that time.

After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Sichuan Huiyu Pharmaceutical as a stock to potentially avoid with its 42.7x 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.

For instance, Sichuan Huiyu Pharmaceutical'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. 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?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. This means it has also seen a slide in earnings over the longer-term as EPS is down 67% 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 42% 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 Sichuan Huiyu Pharmaceutical 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.

What We Can Learn From Sichuan Huiyu Pharmaceutical's P/E?

Sichuan Huiyu Pharmaceutical's P/E is getting right up there since its shares have risen strongly. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Sichuan Huiyu Pharmaceutical 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Sichuan Huiyu Pharmaceutical that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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.