Shandong Homey Aquatic Development Co.,Ltd. (SHSE:600467) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 37% share price drop.

Although its price has dipped substantially, Shandong Homey Aquatic DevelopmentLtd's price-to-earnings (or "P/E") ratio of 44.7x might still make it look like a strong 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 17x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shandong Homey Aquatic DevelopmentLtd's receding earnings in recent times would have to be some food for thought. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shandong Homey Aquatic DevelopmentLtd?

The only time you'd be truly comfortable seeing a P/E as steep as Shandong Homey Aquatic DevelopmentLtd's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 15%. This means it has also seen a slide in earnings over the longer-term as EPS is down 21% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Shandong Homey Aquatic DevelopmentLtd's P/E sits above the majority of other companies. 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. 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

Shandong Homey Aquatic DevelopmentLtd's shares may have retreated, but its P/E is still flying high. 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.

We've established that Shandong Homey Aquatic DevelopmentLtd 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. 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 take the next step, you should know about the 4 warning signs for Shandong Homey Aquatic DevelopmentLtd (2 shouldn't be ignored!) that we have uncovered.

You might be able to find a better investment than Shandong Homey Aquatic DevelopmentLtd. 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.

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