Fujian Yuanxiang New Materials Co.,Ltd (SZSE:301300) shares have had a really impressive month, gaining 54% after a shaky period beforehand. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, Fujian Yuanxiang New MaterialsLtd's price-to-earnings (or "P/E") ratio of 63.9x might 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 27x and even P/E's below 16x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Fujian Yuanxiang New MaterialsLtd's receding earnings in recent times would have to be some food for thought. 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.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Fujian Yuanxiang New MaterialsLtd's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 38%. The last three years don't look nice either as the company has shrunk EPS by 67% 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 36% shows it's an unpleasant look.

In light of this, it's alarming that Fujian Yuanxiang New MaterialsLtd'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. 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 Key Takeaway

The strong share price surge has got Fujian Yuanxiang New MaterialsLtd's P/E rushing to great heights as well. 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.

We've established that Fujian Yuanxiang New MaterialsLtd 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You need to take note of risks, for example - Fujian Yuanxiang New MaterialsLtd has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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