Shanghai New Huang Pu Industrial Group Co., Ltd.'s (SHSE:600638) price-to-earnings (or "P/E") ratio of 49.4x might make it look like a strong 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 highly elevated P/E.

Shanghai New Huang Pu Industrial Group 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. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Shanghai New Huang Pu Industrial Group's to be considered reasonable.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. Still, lamentably EPS has fallen 77% 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.

Comparing that to the market, which is predicted to deliver 36% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Shanghai New Huang Pu Industrial Group's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On Shanghai New Huang Pu Industrial Group's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shanghai New Huang Pu Industrial Group revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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.

It is also worth noting that we have found 2 warning signs for Shanghai New Huang Pu Industrial Group (1 doesn't sit too well with us!) that you need to take into consideration.

You might be able to find a better investment than Shanghai New Huang Pu Industrial Group. 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).

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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.

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