There's Reason For Concern Over Shanghai Sinotec Co., Ltd.'s (SHSE:603121) Massive 32% Price Jump

Those holding Shanghai Sinotec Co., Ltd. (SHSE:603121) shares would be relieved that the share price has rebounded 32% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, despite the strong performance over the last month, the full year gain of 5.8% isn't as attractive.

After such a large jump in price, Shanghai Sinotec may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 34.5x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. 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.

With earnings growth that's exceedingly strong of late, Shanghai Sinotec has been doing very well. The P/E is probably high because investors think this strong earnings growth will be 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.

View 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.

How Is Shanghai Sinotec's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 291% last year. As a result, it also grew EPS by 9.0% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.

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. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with Shanghai Sinotec (including 1 which is a bit unpleasant).

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

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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.