Earnings Not Telling The Story For Shanghai Lianming Machinery Co., Ltd. (SHSE:603006) After Shares Rise 28%

Despite an already strong run, Shanghai Lianming Machinery Co., Ltd. (SHSE:603006) shares have been powering on, with a gain of 28% in the last thirty days. Notwithstanding the latest gain, the annual share price return of 9.8% isn't as impressive.

After such a large jump in price, Shanghai Lianming Machinery's price-to-earnings (or "P/E") ratio of 61.7x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 37x and even P/E's below 21x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shanghai Lianming Machinery'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.

Check out our latest analysis for Shanghai Lianming Machinery

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Shanghai Lianming Machinery's earnings, revenue and cash flow.

Is There Enough Growth For Shanghai Lianming Machinery?

Shanghai Lianming Machinery's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 64% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 63% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 40% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shanghai Lianming Machinery 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. 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 Shanghai Lianming Machinery have built up some good momentum lately, which has really inflated its P/E. 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 Shanghai Lianming Machinery 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. 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.

You always need to take note of risks, for example - Shanghai Lianming Machinery has 2 warning signs we think you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.