Despite an already strong run, Shenglong Splendecor International Limited (HKG:8481) shares have been powering on, with a gain of 27% in the last thirty days. The annual gain comes to 164% following the latest surge, making investors sit up and take notice.

In spite of the firm bounce in price, it's still not a stretch to say that Shenglong Splendecor International's price-to-earnings (or "P/E") ratio of 7.3x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been quite advantageous for Shenglong Splendecor International as its earnings have been rising very briskly. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

Does Growth Match The P/E?

Shenglong Splendecor International's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

If we review the last year of earnings growth, the company posted a terrific increase of 166%. The strong recent performance means it was also able to grow EPS by 87% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Comparing that to the market, which is predicted to deliver 21% growth in the next 12 months, the company's momentum is pretty similar based on recent medium-term annualised earnings results.

In light of this, it's understandable that Shenglong Splendecor International's P/E sits in line with the majority of other companies. It seems most investors are expecting to see average growth rates continue into the future and are only willing to pay a moderate amount for the stock.

The Final Word

Its shares have lifted substantially and now Shenglong Splendecor International's P/E is also back up to the market median. 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.

As we suspected, our examination of Shenglong Splendecor International revealed its three-year earnings trends are contributing to its P/E, given they look similar to current market expectations. At this stage investors feel the potential for an improvement or deterioration in earnings isn't great enough to justify a high or low P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Shenglong Splendecor International (1 shouldn't be ignored!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than Shenglong Splendecor International. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.