When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 28x, you may consider Betta Pharmaceuticals Co., Ltd. (SZSE:300558) as a stock to potentially avoid with its 36.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Betta Pharmaceuticals certainly has been doing a good job lately as it's been growing earnings more 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.

How Is Betta Pharmaceuticals' Growth Trending?

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

Retrospectively, the last year delivered an exceptional 250% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 38% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 19% per annum as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 24% each year, which is noticeably more attractive.

With this information, we find it concerning that Betta Pharmaceuticals 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.

We've established that Betta Pharmaceuticals currently trades on a much 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 high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 1 warning sign for Betta Pharmaceuticals that you should be aware of.

If these risks are making you reconsider your opinion on Betta Pharmaceuticals, 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