Nanjing Xinlian Electronics Co., Ltd (SZSE:002546) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 13% share price drop.

Even after such a large drop in price, it's still not a stretch to say that Nanjing Xinlian Electronics' price-to-earnings (or "P/E") ratio of 28.3x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 28x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

As an illustration, earnings have deteriorated at Nanjing Xinlian Electronics over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Nanjing Xinlian Electronics' is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered a frustrating 33% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 41% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

In light of this, it's somewhat alarming that Nanjing Xinlian Electronics' P/E sits in line with 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 on the share price eventually.

What We Can Learn From Nanjing Xinlian Electronics' P/E?

With its share price falling into a hole, the P/E for Nanjing Xinlian Electronics looks quite average now. 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 Nanjing Xinlian Electronics revealed its shrinking earnings over the medium-term aren't impacting its P/E 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 moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Nanjing Xinlian Electronics (at least 2 which make us uncomfortable), and understanding these should be part of your investment process.

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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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.