Donglai Coating Technology (Shanghai) Co., Ltd. (SHSE:688129) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 15% in that time.

Although its price has dipped substantially, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Donglai Coating Technology (Shanghai) as a stock to avoid entirely with its 50.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Donglai Coating Technology (Shanghai)'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?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Donglai Coating Technology (Shanghai)'s to be considered reasonable.

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 44%. This means it has also seen a slide in earnings over the longer-term as EPS is down 72% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

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 Donglai Coating Technology (Shanghai) is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Donglai Coating Technology (Shanghai)'s P/E?

Donglai Coating Technology (Shanghai)'s shares may have retreated, but its P/E is still flying high. 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 Donglai Coating Technology (Shanghai) 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.

Having said that, be aware Donglai Coating Technology (Shanghai) is showing 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

If these risks are making you reconsider your opinion on Donglai Coating Technology (Shanghai), explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.