The ChengDa Pharmaceuticals Co., Ltd. (SZSE:301201) share price has done very well over the last month, posting an excellent gain of 42%. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Following the firm bounce in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider ChengDa Pharmaceuticals as a stock to potentially avoid with its 43.1x P/E ratio. 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.

ChengDa Pharmaceuticals 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For ChengDa Pharmaceuticals?

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

Retrospectively, the last year delivered an exceptional 24% gain to the company's bottom line. Still, incredibly EPS has fallen 47% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that ChengDa Pharmaceuticals is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From ChengDa Pharmaceuticals' P/E?

ChengDa Pharmaceuticals shares have received a push in the right direction, but its P/E is elevated too. 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.

Our examination of ChengDa Pharmaceuticals 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for ChengDa Pharmaceuticals (2 shouldn't be ignored) you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.