The Shenzhen Kaizhong Precision Technology Co., Ltd. (SZSE:002823) share price has fared very poorly over the last month, falling by a substantial 25%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 11% share price drop.

In spite of the heavy fall in price, Shenzhen Kaizhong Precision Technology may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 76.5x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 17x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Shenzhen Kaizhong Precision Technology 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Shenzhen Kaizhong Precision Technology?

In order to justify its P/E ratio, Shenzhen Kaizhong Precision Technology would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 6.5%. The last three years don't look nice either as the company has shrunk EPS by 68% in aggregate. 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 42% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Shenzhen Kaizhong Precision Technology'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.

What We Can Learn From Shenzhen Kaizhong Precision Technology's P/E?

A significant share price dive has done very little to deflate Shenzhen Kaizhong Precision Technology's very lofty P/E. 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 Shenzhen Kaizhong Precision Technology 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. 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 Kaizhong Precision Technology is showing 3 warning signs in our investment analysis, and 2 of those are a bit unpleasant.

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.