Shenzhen SDG Service Co.,Ltd. (SZSE:300917) shares have had a really impressive month, gaining 52% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 52% in the last year.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may consider Shenzhen SDG ServiceLtd as a stock to avoid entirely with its 61.1x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Shenzhen SDG ServiceLtd's financial performance has been poor lately as its earnings have been in decline. 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.

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 Shenzhen SDG ServiceLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 1.4% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 7.8% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

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.

With this information, we find it concerning that Shenzhen SDG ServiceLtd is trading at a P/E higher than the market. 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 Key Takeaway

Shenzhen SDG ServiceLtd's P/E is flying high just like its stock has during the last month. 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 SDG ServiceLtd 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 Shenzhen SDG ServiceLtd is showing 1 warning sign in our investment analysis, you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.