Sanyou Corporation Limited (SZSE:300932) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 28% in that time.

In spite of the heavy fall in price, Sanyou's price-to-earnings (or "P/E") ratio of 43.2x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 29x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Sanyou 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Sanyou

Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. As a result, earnings from three years ago have also fallen 75% 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 42% shows it's an unpleasant look.

In light of this, it's alarming that Sanyou'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. There's a very 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.

What We Can Learn From Sanyou's P/E?

Despite the recent share price weakness, Sanyou's P/E remains higher than most other companies. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Sanyou 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Sanyou (1 is a bit unpleasant!) that you need to take into consideration.

If these risks are making you reconsider your opinion on Sanyou, explore our interactive list of high quality stocks to get an idea of what else is out there.

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