Shaanxi Fenghuo Electronics Co., Ltd. (SZSE:000561) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 42% share price drop.

Although its price has dipped substantially, Shaanxi Fenghuo Electronics may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 50.4x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 17x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Shaanxi Fenghuo Electronics' 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 Shaanxi Fenghuo Electronics' Growth Trending?

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

Retrospectively, the last year delivered a frustrating 32% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 22% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 42% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Shaanxi Fenghuo Electronics' 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, Shaanxi Fenghuo Electronics' P/E still exceeds the rest of the market significantly. 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.

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

Before you take the next step, you should know about the 2 warning signs for Shaanxi Fenghuo Electronics that we have uncovered.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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