To the annoyance of some shareholders, Guangdong Sanhe Pile Co., Ltd. (SZSE:003037) shares are down a considerable 26% in the last month, which continues a horrid run for the company. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 64% loss during 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 Guangdong Sanhe Pile as a stock to potentially avoid with its 34.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Guangdong Sanhe Pile over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do 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.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Guangdong Sanhe Pile's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 42%. As a result, earnings from three years ago have also fallen 79% 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 36% shows it's an unpleasant look.

With this information, we find it concerning that Guangdong Sanhe Pile 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. 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.

What We Can Learn From Guangdong Sanhe Pile's P/E?

Despite the recent share price weakness, Guangdong Sanhe Pile's P/E remains higher than most other companies. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Guangdong Sanhe Pile 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 4 warning signs for Guangdong Sanhe Pile (1 can't be ignored!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Guangdong Sanhe Pile, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com