Yeal Electric Co., Ltd. (SZSE:300923) shareholders would be excited to see that the share price has had a great month, posting a 39% gain and recovering from prior weakness. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 7.7% in the last twelve months.

After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 26x, you may consider Yeal Electric as a stock to potentially avoid with its 38.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Yeal Electric over the last year, which is not ideal at all. 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 Yeal Electric?

The only time you'd be truly comfortable seeing a P/E as high as Yeal Electric's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 5.8% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 46% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 35% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Yeal Electric is trading at a P/E higher than the market. 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 Final Word

Yeal Electric shares have received a push in the right direction, but its P/E is elevated too. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

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

Having said that, be aware Yeal Electric is showing 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

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.

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