Shanghai Stonehill Technology Co., Ltd. (SZSE:002195) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month, although it is still struggling to make up recently lost ground. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 5.3% in the last twelve months.
After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Shanghai Stonehill Technology as a stock to avoid entirely with its 73.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
As an illustration, earnings have deteriorated at Shanghai Stonehill Technology over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Shanghai Stonehill Technology's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. As a result, earnings from three years ago have also fallen 32% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 41% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Shanghai Stonehill Technology's P/E sits above the majority of other companies. 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 Bottom Line On Shanghai Stonehill Technology's P/E
Shares in Shanghai Stonehill Technology have built up some good momentum lately, which has really inflated its P/E. 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 Stonehill Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Before you take the next step, you should know about the 4 warning signs for Shanghai Stonehill Technology (1 is potentially serious!) that we have uncovered.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.