Shenzhen Topway Video Communication Co., Ltd (SZSE:002238) shares have retraced a considerable 28% in the last month, reversing a fair amount of their solid recent performance. Longer-term, the stock has been solid despite a difficult 30 days, gaining 24% in the last year.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Shenzhen Topway Video Communication as a stock to avoid entirely with its 71x 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 so lofty.

We'd have to say that with no tangible growth over the last year, Shenzhen Topway Video Communication's earnings have been unimpressive. One possibility is that the P/E is high because investors think the benign earnings growth will improve 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.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Shenzhen Topway Video Communication's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 38% decline in EPS over the last three years in total. 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 42% shows it's an unpleasant look.

With this information, we find it concerning that Shenzhen Topway Video Communication 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 Shenzhen Topway Video Communication's P/E

Shenzhen Topway Video Communication's shares may have retreated, but its P/E is still flying high. 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.

We've established that Shenzhen Topway Video Communication 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with Shenzhen Topway Video Communication (including 2 which are a bit unpleasant).

If you're unsure about the strength of Shenzhen Topway Video Communication'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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