Sprocomm Intelligence Limited (HKG:1401) shareholders won't be pleased to see that the share price has had a very rough month, dropping 88% and undoing the prior period's positive performance. For any long-term shareholders, the last month ends a year to forget by locking in a 54% share price decline.

Even after such a large drop in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may still consider Sprocomm Intelligence as a stock to avoid entirely with its 39.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's exceedingly strong of late, Sprocomm Intelligence has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little 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, Sprocomm Intelligence would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 301% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Sprocomm Intelligence is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

The Bottom Line On Sprocomm Intelligence's P/E

A significant share price dive has done very little to deflate Sprocomm Intelligence's very lofty P/E. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Sprocomm Intelligence revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Sprocomm Intelligence (at least 2 which make us uncomfortable), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Sprocomm Intelligence, 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.