Guoguang Electric Co.,Ltd.Chengdu (SHSE:688776) shares have had a horrible month, losing 26% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 44% share price drop.

In spite of the heavy fall in price, Guoguang ElectricLtd.Chengdu's price-to-earnings (or "P/E") ratio of 51.9x might still make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 28x and even P/E's below 17x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Guoguang ElectricLtd.Chengdu's receding earnings in recent times would have to be some food for thought. 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.

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

The only time you'd be truly comfortable seeing a P/E as steep as Guoguang ElectricLtd.Chengdu's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 32% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 26% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

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

With this information, we find it concerning that Guoguang ElectricLtd.Chengdu 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 Guoguang ElectricLtd.Chengdu's P/E?

A significant share price dive has done very little to deflate Guoguang ElectricLtd.Chengdu'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 Guoguang ElectricLtd.Chengdu 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Guoguang ElectricLtd.Chengdu with six simple checks on some of these key factors.

You might be able to find a better investment than Guoguang ElectricLtd.Chengdu. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

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