Shandong Wohua Pharmaceutical Co., Ltd. (SZSE:002107) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 26% in the last twelve months.

Even after such a large jump in price, there still wouldn't be many who think Shandong Wohua Pharmaceutical's price-to-earnings (or "P/E") ratio of 32x is worth a mention when the median P/E in China is similar at about 31x. 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.

As an illustration, earnings have deteriorated at Shandong Wohua Pharmaceutical over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Shandong Wohua Pharmaceutical's Growth Trending?

In order to justify its P/E ratio, Shandong Wohua Pharmaceutical would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 18% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 54% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 40% shows it's an unpleasant look.

In light of this, it's somewhat alarming that Shandong Wohua Pharmaceutical's P/E sits in line with 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 on the share price eventually.

The Final Word

Shandong Wohua Pharmaceutical's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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.

Our examination of Shandong Wohua Pharmaceutical revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Shandong Wohua Pharmaceutical with six simple checks.

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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