When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider Qingdao Topscomm Communication INC. (SHSE:603421) as a stock to avoid entirely with its 58.9x 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 so lofty.

For example, consider that Qingdao Topscomm Communication's financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Qingdao Topscomm Communication

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Qingdao Topscomm Communication's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 62%. As a result, earnings from three years ago have also fallen 19% overall. 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 43% shows it's an unpleasant look.

With this information, we find it concerning that Qingdao Topscomm Communication is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate 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 Qingdao Topscomm Communication's P/E

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.

We've established that Qingdao Topscomm Communication currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Qingdao Topscomm Communication (1 is significant!) that you should be aware of before investing here.

You might be able to find a better investment than Qingdao Topscomm Communication. 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.