Shanghai Kai Kai Industry Company Limited (SHSE:600272) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 6.6% isn't as impressive.

After such a large jump in price, Shanghai Kai Kai Industry may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 50.7x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 16x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for Shanghai Kai Kai Industry as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Shanghai Kai Kai Industry would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 31%. The strong recent performance means it was also able to grow EPS by 288% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

This is in contrast to the rest of the market, which is expected to grow by 35% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Shanghai Kai Kai Industry's P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Final Word

Shares in Shanghai Kai Kai Industry have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Shanghai Kai Kai Industry maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless the recent medium-term conditions change, they will continue to provide strong support to the share price.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Shanghai Kai Kai Industry (1 is a bit unpleasant!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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