With a price-to-earnings (or "P/E") ratio of 36.1x Wanxiang Doneed Co., ltd (SHSE:600371) may be sending bearish signals at the moment, given that 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 as high as it is.

For example, consider that Wanxiang Doneed's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do 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.

Is There Enough Growth For Wanxiang Doneed?

In order to justify its P/E ratio, Wanxiang Doneed would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 1.1% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 22% in total. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

This is in contrast to the rest of the market, which is expected to grow by 41% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Wanxiang Doneed's P/E sits above the majority of other companies. 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 Wanxiang Doneed's 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.

Our examination of Wanxiang Doneed revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

Before you settle on your opinion, we've discovered 2 warning signs for Wanxiang Doneed (1 doesn't sit too well with us!) that you should be aware of.

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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