Sheng Yuan Holdings Limited (HKG:851) shares have continued their recent momentum with a 27% gain in the last month alone. But not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.

Since its price has surged higher, Sheng Yuan Holdings' price-to-earnings (or "P/E") ratio of 45.2x 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 8x and even P/E's below 5x 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.

For example, consider that Sheng Yuan Holdings' financial performance has been poor lately as it's earnings have been in decline. 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.

See our latest analysis for Sheng Yuan Holdings

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 Sheng Yuan Holdings' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 63%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 17% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Sheng Yuan Holdings 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. 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

The strong share price surge has got Sheng Yuan Holdings' P/E rushing to great heights as well. 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.

Our examination of Sheng Yuan Holdings revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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. 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.

Before you settle on your opinion, we've discovered 5 warning signs for Sheng Yuan Holdings (2 are potentially serious!) that you should be aware of.

You might be able to find a better investment than Sheng Yuan Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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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.