With a price-to-earnings (or "P/E") ratio of 34.9x ShanDongDenghai Seeds Co.,Ltd (SZSE:002041) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 31x and even P/E's lower than 19x are not unusual. 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.

With earnings growth that's superior to most other companies of late, ShanDongDenghai SeedsLtd has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For ShanDongDenghai SeedsLtd?

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

If we review the last year of earnings growth, the company posted a terrific increase of 25%. The strong recent performance means it was also able to grow EPS by 89% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 23% per year during the coming three years according to the nine analysts following the company. Meanwhile, the rest of the market is forecast to expand by 26% per annum, which is noticeably more attractive.

With this information, we find it concerning that ShanDongDenghai SeedsLtd is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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.

Our examination of ShanDongDenghai SeedsLtd's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - ShanDongDenghai SeedsLtd has 1 warning sign we think you should be aware of.

You might be able to find a better investment than ShanDongDenghai SeedsLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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.