Shandong Longji Machinery Co.,Ltd (SZSE:002363) 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 29% in that time.

In spite of the heavy fall in price, Shandong Longji MachineryLtd's price-to-earnings (or "P/E") ratio of 55.8x might still make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 17x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

We'd have to say that with no tangible growth over the last year, Shandong Longji MachineryLtd'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. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Shandong Longji MachineryLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. The lack of growth did nothing to help the company's aggregate three-year performance, which is an unsavory 8.7% drop in EPS. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 41% 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 Shandong Longji MachineryLtd 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On Shandong Longji MachineryLtd's P/E

A significant share price dive has done very little to deflate Shandong Longji MachineryLtd's very lofty P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Shandong Longji MachineryLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. 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.

You should always think about risks. Case in point, we've spotted 6 warning signs for Shandong Longji MachineryLtd you should be aware of, and 2 of them make us uncomfortable.

If these risks are making you reconsider your opinion on Shandong Longji MachineryLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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