Unpleasant Surprises Could Be In Store For Zhejiang Wanfeng Chemical Co.,Ltd.'s (SHSE:603172) Shares

With a price-to-earnings (or "P/E") ratio of 67x Zhejiang Wanfeng Chemical Co.,Ltd. (SHSE:603172) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 36x and even P/E's lower than 21x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Zhejiang Wanfeng ChemicalLtd over the last year, which is not ideal at all. 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.

See our latest analysis for Zhejiang Wanfeng ChemicalLtd

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 Zhejiang Wanfeng ChemicalLtd's earnings, revenue and cash flow.

How Is Zhejiang Wanfeng ChemicalLtd's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Zhejiang Wanfeng ChemicalLtd's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 53%. The last three years don't look nice either as the company has shrunk EPS by 73% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Zhejiang Wanfeng ChemicalLtd 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 Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Zhejiang Wanfeng ChemicalLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Zhejiang Wanfeng ChemicalLtd (at least 1 which is a bit concerning), and understanding these should be part of your investment process.

If you're unsure about the strength of Zhejiang Wanfeng ChemicalLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.