Shenzhen Yanmade Technology Inc. (SHSE:688312) shareholders have had their patience rewarded with a 25% share price jump in the last month. Taking a wider view, although not as strong as the last month, the full year gain of 16% is also fairly reasonable.

Following the firm bounce in price, Shenzhen Yanmade Technology's price-to-earnings (or "P/E") ratio of 39.5x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 29x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

It looks like earnings growth has deserted Shenzhen Yanmade Technology recently, which is not something to boast about. It might be that many are expecting an improvement to the uninspiring earnings performance over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

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

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 35% decline in EPS over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 37% shows it's an unpleasant look.

In light of this, it's alarming that Shenzhen Yanmade 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 Final Word

Shenzhen Yanmade Technology's P/E is getting right up there since its shares have risen strongly. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Shenzhen Yanmade 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. 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.

Having said that, be aware Shenzhen Yanmade Technology is showing 3 warning signs in our investment analysis, and 2 of those shouldn't be ignored.

If these risks are making you reconsider your opinion on Shenzhen Yanmade Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com