The Shandong Shanda Oumasoft CO.,LTD. (SZSE:301185) share price has fared very poorly over the last month, falling by a substantial 26%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 17% in that time.

Even after such a large drop in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Shandong Shanda OumasoftLTD as a stock to potentially avoid with its 36.2x 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 as high as it is.

For example, consider that Shandong Shanda OumasoftLTD's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

In order to justify its P/E ratio, Shandong Shanda OumasoftLTD would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 27% in aggregate. 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 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 Shanda OumasoftLTD 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 Key Takeaway

Shandong Shanda OumasoftLTD's P/E hasn't come down all the way after its stock plunged. 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 Shandong Shanda OumasoftLTD 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Shandong Shanda OumasoftLTD, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Shandong Shanda OumasoftLTD, 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.