Optimistic Investors Push Shanghai Sinotec Co., Ltd. (SHSE:603121) Shares Up 30% But Growth Is Lacking

Shanghai Sinotec Co., Ltd. (SHSE:603121) shares have continued their recent momentum with a 30% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 65%.

Following the firm bounce in price, Shanghai Sinotec's price-to-earnings (or "P/E") ratio of 50.4x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 34x and even P/E's below 19x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for Shanghai Sinotec as its earnings have been rising very briskly. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Shanghai Sinotec

Although there are no analyst estimates available for Shanghai Sinotec, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Shanghai Sinotec's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 37% gain to the company's bottom line. As a result, it also grew EPS by 27% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 38% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Shanghai Sinotec'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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

Shanghai Sinotec shares have received a push in the right direction, but its P/E is elevated too. 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 Shanghai Sinotec currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanghai Sinotec, and understanding them should be part of your investment process.

You might be able to find a better investment than Shanghai Sinotec. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.