When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 31x, you may consider Grinm Advanced Materials Co., Ltd. (SHSE:600206) as a stock to potentially avoid with its 42.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings growth that's exceedingly strong of late, Grinm Advanced Materials has been doing very well. 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.

Is There Enough Growth For Grinm Advanced Materials?

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

If we review the last year of earnings growth, the company posted a terrific increase of 62%. However, this wasn't enough as the latest three year period has seen a very unpleasant 12% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 37% shows it's an unpleasant look.

With this information, we find it concerning that Grinm Advanced Materials is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Grinm Advanced Materials' P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Grinm Advanced Materials currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 2 warning signs we've spotted with Grinm Advanced Materials.

Of course, you might also be able to find a better stock than Grinm Advanced Materials. 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.