Anhui Quanchai Engine Co., Ltd. (SHSE:600218) shares have had a horrible month, losing 26% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 23% share price drop.

Although its price has dipped substantially, Anhui Quanchai Engine may still be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 31.7x, 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 high for a reason and it requires further investigation to determine if it's justified.

For instance, Anhui Quanchai Engine'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Growth Metrics Telling Us About The High P/E?

Anhui Quanchai Engine's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 12% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 43% 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.

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.

With this information, we find it concerning that Anhui Quanchai Engine 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 Bottom Line On Anhui Quanchai Engine's P/E

Despite the recent share price weakness, Anhui Quanchai Engine's P/E remains higher than most other companies. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Anhui Quanchai Engine 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.

Having said that, be aware Anhui Quanchai Engine is showing 3 warning signs in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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