Earnings Not Telling The Story For Shanghai Electric Group Co., Ltd. (HKG:2727) After Shares Rise 25%

Shanghai Electric Group Co., Ltd. (HKG:2727) shares have continued their recent momentum with a 25% gain in the last month alone. The last month tops off a massive increase of 143% in the last year.

Following the firm bounce in price, Shanghai Electric Group's price-to-earnings (or "P/E") ratio of 56.4x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 12x and even P/E's below 7x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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With earnings growth that's superior to most other companies of late, Shanghai Electric Group has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Shanghai Electric Group

Keen to find out how analysts think Shanghai Electric Group's future stacks up against the industry? In that case, our free report is a great place to start.

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

In order to justify its P/E ratio, Shanghai Electric Group would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 67% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 8.6% each year during the coming three years according to the two analysts following the company. That's shaping up to be materially lower than the 15% per year growth forecast for the broader market.

In light of this, it's alarming that Shanghai Electric Group'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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Shanghai Electric Group's P/E is flying high just like its stock has during the last month. 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 Electric Group's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Shanghai Electric Group with six simple checks on some of these key factors.

If you're unsure about the strength of Shanghai Electric Group'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.