Linewell Software Co., Ltd. (SHSE:603636) shareholders that were waiting for something to happen have been dealt a blow with a 30% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 49% in that time.

In spite of the heavy fall in price, Linewell Software may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 49.4x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 17x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For example, consider that Linewell Software's financial performance has been poor lately as its earnings have been in decline. 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?

In order to justify its P/E ratio, Linewell Software would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 4.6%. The last three years don't look nice either as the company has shrunk EPS by 19% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

With this information, we find it concerning that Linewell Software is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

Even after such a strong price drop, Linewell Software's P/E still exceeds the rest of the market significantly. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Linewell Software 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. 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 5 warning signs for Linewell Software (2 don't sit too well with us!) that we have uncovered.

You might be able to find a better investment than Linewell Software. 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.