The Nanjing Quanxin Cable Technology Co., Ltd. (SZSE:300447) share price has done very well over the last month, posting an excellent gain of 48%. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider Nanjing Quanxin Cable Technology as a stock to avoid entirely with its 62x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Nanjing Quanxin Cable Technology's financial performance has been poor lately as its earnings have been in decline. 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. 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?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Nanjing Quanxin Cable Technology's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 57% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 54% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 37% shows it's an unpleasant look.

In light of this, it's alarming that Nanjing Quanxin Cable Technology's P/E sits above 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. 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 Final Word

The strong share price surge has got Nanjing Quanxin Cable Technology's P/E rushing to great heights as well. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Nanjing Quanxin Cable Technology revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Nanjing Quanxin Cable Technology, and understanding them should be part of your investment process.

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.