Shanghai Lujiazui Finance & Trade Zone Development Co.,Ltd. (SHSE:600663) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's price-to-earnings (or "P/E") ratio of 46.8x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 32x and even P/E's below 20x 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 as high as it is.

Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 35%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 78% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's P/E is getting right up there since its shares have risen strongly. 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 Lujiazui Finance & Trade Zone DevelopmentLtd 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 is also worth noting that we have found 4 warning signs for Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd (2 are potentially serious!) that you need to take into consideration.

You might be able to find a better investment than Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (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.