Xuelong Group Co.,Ltd (SHSE:603949) shareholders won't be pleased to see that the share price has had a very rough month, dropping 30% and undoing the prior period's positive performance. The recent drop has obliterated the annual return, with the share price now down 4.6% over that longer period.

In spite of the heavy fall in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may still consider Xuelong GroupLtd as a stock to avoid entirely with its 67x P/E ratio. 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.

For instance, Xuelong GroupLtd'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Xuelong GroupLtd

Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 3.8%. As a result, earnings from three years ago have also fallen 65% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 44% 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 Xuelong GroupLtd 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

Even after such a strong price drop, Xuelong GroupLtd'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.

Our examination of Xuelong GroupLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Xuelong GroupLtd (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.

You might be able to find a better investment than Xuelong GroupLtd. 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.