Shanghai Fudan Microelectronics Group Company Limited's (HKG:1385) price-to-earnings (or "P/E") ratio of 12.5x might make it look like a sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 8x and even P/E's below 5x are quite common. 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.

For example, consider that Shanghai Fudan Microelectronics Group's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

What Are Growth Metrics Telling Us About The High P/E?

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

Retrospectively, the last year delivered a frustrating 38% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 96% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the market, which is expected to grow by 22% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we can see why Shanghai Fudan Microelectronics Group is trading at such a high P/E compared to the market. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Shanghai Fudan Microelectronics Group maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 2 warning signs for Shanghai Fudan Microelectronics Group that you should be aware of.

Of course, you might also be able to find a better stock than Shanghai Fudan Microelectronics Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.