Linkage Software Co., LTD (SHSE:688588) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 30% in that time.

Even after such a large drop in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may still consider Linkage Software as a stock to potentially avoid with its 32.6x 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 as high as it is.

As an illustration, earnings have deteriorated at Linkage Software over the last year, which is not ideal at all. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Linkage Software

Is There Enough Growth For Linkage Software?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 12%. As a result, earnings from three years ago have also fallen 37% 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 42% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Linkage Software'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 Bottom Line On Linkage Software's P/E

Despite the recent share price weakness, Linkage Software's P/E remains higher than most other companies. 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 Linkage Software 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. 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.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Linkage Software that you should be aware of.

If you're unsure about the strength of Linkage Software's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.