Despite an already strong run, Shaanxi Meibang Pharmaceutical Group Co., Ltd. (SHSE:605033) shares have been powering on, with a gain of 28% in the last thirty days. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.7% over the last year.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 32x, you may consider Shaanxi Meibang Pharmaceutical Group as a stock to avoid entirely with its 77.7x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shaanxi Meibang Pharmaceutical Group'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shaanxi Meibang Pharmaceutical Group?

In order to justify its P/E ratio, Shaanxi Meibang Pharmaceutical Group would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 70%. As a result, earnings from three years ago have also fallen 75% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's an unpleasant look.

With this information, we find it concerning that Shaanxi Meibang Pharmaceutical Group 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.

The Final Word

Shares in Shaanxi Meibang Pharmaceutical Group have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Shaanxi Meibang Pharmaceutical Group 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.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Shaanxi Meibang Pharmaceutical Group (of which 1 is potentially serious!) you should know about.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.