When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Hansoh Pharmaceutical Group Company Limited (HKG:3692) as a stock to avoid entirely with its 21.8x 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 so lofty.

Hansoh Pharmaceutical Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little 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 far outperform the market for P/E ratios like Hansoh Pharmaceutical Group's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 83% gain to the company's bottom line. The latest three year period has also seen an excellent 78% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 0.3% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 12% each year, which is noticeably more attractive.

In light of this, it's alarming that Hansoh Pharmaceutical Group's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Hansoh Pharmaceutical Group's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Hansoh Pharmaceutical Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 1 warning sign for Hansoh Pharmaceutical Group that we have uncovered.

If you're unsure about the strength of Hansoh Pharmaceutical Group'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.