Zhejiang Kan Specialities Material Co., Ltd.'s (SZSE:002012) price-to-earnings (or "P/E") ratio of 55.4x 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 33x and even P/E's below 20x 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.

For example, consider that Zhejiang Kan Specialities Material'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.

View our latest analysis for Zhejiang Kan Specialities Material

How Is Zhejiang Kan Specialities Material's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. This means it has also seen a slide in earnings over the longer-term as EPS is down 26% in total over the last three years. 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 43% shows it's an unpleasant look.

In light of this, it's alarming that Zhejiang Kan Specialities Material'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. 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

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zhejiang Kan Specialities Material 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.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Zhejiang Kan Specialities Material with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than Zhejiang Kan Specialities Material. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.