Shanghai Shen Lian Biomedical Corporation's (SHSE:688098) Popularity With Investors Is Under Threat From Overpricing

With a price-to-earnings (or "P/E") ratio of 64x Shanghai Shen Lian Biomedical Corporation (SHSE:688098) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 30x and even P/E's lower than 19x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at Shanghai Shen Lian Biomedical 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Shanghai Shen Lian Biomedical

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Shanghai Shen Lian Biomedical will help you shine a light on its historical performance.

Does Growth Match The High P/E?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 47%. The last three years don't look nice either as the company has shrunk EPS by 76% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's an unpleasant look.

With this information, we find it concerning that Shanghai Shen Lian Biomedical is trading at a P/E higher than the market. 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. 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 Final Word

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 Shanghai Shen Lian Biomedical 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. 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 3 warning signs with Shanghai Shen Lian Biomedical (at least 2 which make us uncomfortable), and understanding these should be part of your investment process.

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.

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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.