Shennan Circuit Company Limited (SZSE:002916) shareholders have had their patience rewarded with a 33% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 61%.

Since its price has surged higher, Shennan Circuit's price-to-earnings (or "P/E") ratio of 41.5x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 16x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been advantageous for Shennan Circuit as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shennan Circuit?

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

If we review the last year of earnings growth, the company posted a worthy increase of 5.4%. The latest three year period has also seen a 5.3% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Looking ahead now, EPS is anticipated to climb by 15% each year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 25% per year growth forecast for the broader market.

In light of this, it's alarming that Shennan Circuit's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Shennan Circuit's P/E

The large bounce in Shennan Circuit's shares has lifted the company's P/E to a fairly high level. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shennan Circuit'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 should always think about risks. Case in point, we've spotted 1 warning sign for Shennan Circuit you should be aware of.

If these risks are making you reconsider your opinion on Shennan Circuit, 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.

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