Union Semiconductor (Hefei) Co., Ltd. (SHSE:688403) shareholders have had their patience rewarded with a 36% share price jump in the last month. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 6.3% over the last year.

Since its price has surged higher, Union Semiconductor (Hefei) may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 49.8x, since almost half of all companies in China have P/E ratios under 33x and even P/E's lower than 19x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, Union Semiconductor (Hefei)'s receding earnings in recent times would have to be some food for thought. 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.

Is There Enough Growth For Union Semiconductor (Hefei)?

There's an inherent assumption that a company should outperform the market for P/E ratios like Union Semiconductor (Hefei)'s to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 10%. As a result, earnings from three years ago have also fallen 11% overall. 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.

In light of this, it's alarming that Union Semiconductor (Hefei)'s P/E sits above the majority of other companies. 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.

The Bottom Line On Union Semiconductor (Hefei)'s P/E

The large bounce in Union Semiconductor (Hefei)'s shares has lifted the company's P/E to a fairly high level. 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.

Our examination of Union Semiconductor (Hefei) 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Union Semiconductor (Hefei), and understanding them should be part of your investment process.

If you're unsure about the strength of Union Semiconductor (Hefei)'s business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.