Chengdu Tianjian Technology Co., Ltd. (SZSE:002977) shares have had a horrible month, losing 27% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 14% share price drop.

Although its price has dipped substantially, Chengdu Tianjian Technology's price-to-earnings (or "P/E") ratio of 66.8x 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 28x and even P/E's below 17x are quite common. 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.

As an illustration, earnings have deteriorated at Chengdu Tianjian Technology over the last year, which is not ideal at all. 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.

Is There Enough Growth For Chengdu Tianjian Technology?

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

Retrospectively, the last year delivered a frustrating 31% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 43% in aggregate. 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 36% shows it's an unpleasant look.

In light of this, it's alarming that Chengdu Tianjian 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. 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, Chengdu Tianjian Technology's P/E still exceeds the rest of the market significantly. 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 Chengdu Tianjian Technology 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Chengdu Tianjian Technology (of which 2 can't be ignored!) you should know about.

You might be able to find a better investment than Chengdu Tianjian Technology. 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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