What Zhejiang Medicine Co., Ltd.'s (SHSE:600216) 27% Share Price Gain Is Not Telling You

The Zhejiang Medicine Co., Ltd. (SHSE:600216) share price has done very well over the last month, posting an excellent gain of 27%. Looking back a bit further, it's encouraging to see the stock is up 29% in the last year.

After such a large jump in price, Zhejiang Medicine may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 31.6x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 16x 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 superior to most other companies of late, Zhejiang Medicine has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Zhejiang Medicine

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Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a decent 6.9% gain to the company's bottom line. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 49% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 19% per annum during the coming three years according to the two analysts following the company. With the market predicted to deliver 24% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Zhejiang Medicine's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Zhejiang Medicine's P/E

Zhejiang Medicine shares have received a push in the right direction, but its P/E is elevated too. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Zhejiang Medicine currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places 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 Zhejiang Medicine, and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.

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