Guangdong High Dream Intellectualized Machinery Co., Ltd. (SZSE:300720) shares have had a horrible month, losing 28% after a relatively good period beforehand. The last month has meant the stock is now only up 9.9% during the last year.

Although its price has dipped substantially, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 28x, you may still consider Guangdong High Dream Intellectualized Machinery as a stock to avoid entirely with its 70.3x 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 Guangdong High Dream Intellectualized Machinery's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Guangdong High Dream Intellectualized Machinery's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Guangdong High Dream Intellectualized Machinery's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 4.1%. This means it has also seen a slide in earnings over the longer-term as EPS is down 54% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's an unpleasant look.

In light of this, it's alarming that Guangdong High Dream Intellectualized Machinery's P/E sits above the majority of other companies. 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.

The Key Takeaway

Even after such a strong price drop, Guangdong High Dream Intellectualized Machinery's P/E still exceeds the rest of the market significantly. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Guangdong High Dream Intellectualized Machinery 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.

You need to take note of risks, for example - Guangdong High Dream Intellectualized Machinery has 3 warning signs (and 2 which can't be ignored) we think you should know about.

If you're unsure about the strength of Guangdong High Dream Intellectualized Machinery's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com