Those holding Jiangsu Lidao New Materials Co., Ltd. (SHSE:603937) shares would be relieved that the share price has rebounded 31% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

Even after such a large jump in price, there still wouldn't be many who think Jiangsu Lidao New Materials' price-to-earnings (or "P/E") ratio of 33.2x is worth a mention when the median P/E in China is similar at about 31x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

As an illustration, earnings have deteriorated at Jiangsu Lidao New Materials over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

What Are Growth Metrics Telling Us About The P/E?

In order to justify its P/E ratio, Jiangsu Lidao New Materials would need to produce growth that's similar to the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 46%. As a result, earnings from three years ago have also fallen 43% overall. 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.

In light of this, it's somewhat alarming that Jiangsu Lidao New Materials' P/E sits in line with the majority of other companies. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. There's a 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

Its shares have lifted substantially and now Jiangsu Lidao New Materials' P/E is also back up to the market median. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Jiangsu Lidao New Materials revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Jiangsu Lidao New Materials (at least 2 which shouldn't be ignored), and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than Jiangsu Lidao New Materials. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.