With a price-to-earnings (or "P/E") ratio of 49.8x Shandong Golden Empire Precision Machinery Technology Co., Ltd. (SHSE:603270) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 35x and even P/E's lower than 21x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

As an illustration, earnings have deteriorated at Shandong Golden Empire Precision Machinery Technology 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.

Is There Enough Growth For Shandong Golden Empire Precision Machinery Technology?

There's an inherent assumption that a company should outperform the market for P/E ratios like Shandong Golden Empire Precision Machinery Technology's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 52% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 47% in aggregate. 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 39% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Shandong Golden Empire Precision Machinery 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 Bottom Line On Shandong Golden Empire Precision Machinery Technology's P/E

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 Shandong Golden Empire Precision Machinery Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Shandong Golden Empire Precision Machinery Technology (1 can't be ignored!) that you should be aware of.

If these risks are making you reconsider your opinion on Shandong Golden Empire Precision Machinery Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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