It's not a stretch to say that Hualan Biological Engineering Inc.'s (SZSE:002007) price-to-earnings (or "P/E") ratio of 28.5x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 31x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

With earnings growth that's superior to most other companies of late, Hualan Biological Engineering has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

Is There Some Growth For Hualan Biological Engineering?

The only time you'd be comfortable seeing a P/E like Hualan Biological Engineering's is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a worthy increase of 8.9%. Still, lamentably EPS has fallen 4.0% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next year should generate growth of 34% as estimated by the analysts watching the company. With the market predicted to deliver 39% growth , the company is positioned for a weaker earnings result.

In light of this, it's curious that Hualan Biological Engineering's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Key Takeaway

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 Hualan Biological Engineering currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with Hualan Biological Engineering.

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

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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.