To the annoyance of some shareholders, Shanghai Huili Building Materials Co., Ltd. (SHSE:900939) shares are down a considerable 25% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 42% in that time.

Although its price has dipped substantially, Shanghai Huili Building Materials' price-to-earnings (or "P/E") ratio of 40.7x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 31x and even P/E's below 19x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Earnings have risen at a steady rate over the last year for Shanghai Huili Building Materials, which is generally not a bad outcome. One possibility is that the P/E is high because investors think this good earnings growth will be 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.

Is There Enough Growth For Shanghai Huili Building Materials?

There's an inherent assumption that a company should outperform the market for P/E ratios like Shanghai Huili Building Materials' to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 4.0%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 41% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shanghai Huili Building Materials 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. 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 Shanghai Huili Building Materials' P/E

Despite the recent share price weakness, Shanghai Huili Building Materials' P/E remains higher than most other companies. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Shanghai Huili Building Materials 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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Shanghai Huili Building Materials that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.