Chase Science Co., Ltd (SZSE:300941) shareholders that were waiting for something to happen have been dealt a blow with a 38% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 36% share price drop.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 24x, you may still consider Chase Science as a stock to potentially avoid with its 34.9x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

As an illustration, earnings have deteriorated at Chase Science 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Chase Science's Growth Trending?

In order to justify its P/E ratio, Chase Science would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 9.4% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 49% 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 41% shows it's an unpleasant look.

With this information, we find it concerning that Chase Science 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 Chase Science's P/E?

There's still some solid strength behind Chase Science's P/E, if not its share price lately. 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.

Our examination of Chase Science 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 Chase Science (at least 1 which is potentially serious), and understanding them should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.