CIG ShangHai Co., Ltd. (SHSE:603083) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The last month tops off a massive increase of 191% in the last year.

Following the firm bounce in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 25x, you may consider CIG ShangHai as a stock to avoid entirely with its 51.4x 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.

With earnings growth that's exceedingly strong of late, CIG ShangHai has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like CIG ShangHai's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 106%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that CIG ShangHai is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates 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 CIG ShangHai's P/E

Shares in CIG ShangHai 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 CIG ShangHai currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for CIG ShangHai (of which 1 can't be ignored!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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