Shanghai Sinotec Co., Ltd.'s (SHSE:603121) 34% Share Price Surge Not Quite Adding Up

Shanghai Sinotec Co., Ltd. (SHSE:603121) shares have continued their recent momentum with a 34% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 27%.

Since its price has surged higher, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 36x, you may consider Shanghai Sinotec as a stock to potentially avoid with its 44.7x 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 as high as it is.

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.

View our latest analysis for Shanghai Sinotec

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 Sinotec's earnings, revenue and cash flow.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Shanghai Sinotec's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 37%. The latest three year period has also seen a 27% overall rise in EPS, aided extensively by its short-term performance. 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 39% 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.

What We Can Learn From Shanghai Sinotec's P/E?

The large bounce in Shanghai Sinotec's shares has lifted the company's P/E to a fairly high level. 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 Sinotec revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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 should always think about risks. Case in point, we've spotted 1 warning sign for Shanghai Sinotec 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.

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.