Shandong Hongyu Precision Machinery Co., Ltd. (SZSE:002890) shares have had a horrible month, losing 28% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 18% in that time.

Although its price has dipped substantially, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Shandong Hongyu Precision Machinery as a stock to avoid entirely with its 66.5x 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 instance, Shandong Hongyu Precision Machinery'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Shandong Hongyu Precision Machinery?

In order to justify its P/E ratio, Shandong Hongyu Precision Machinery would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 8.7%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 42% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Shandong Hongyu Precision Machinery's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Shandong Hongyu Precision Machinery's P/E

A significant share price dive has done very little to deflate Shandong Hongyu Precision Machinery's very lofty P/E. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Shandong Hongyu Precision Machinery revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

You always need to take note of risks, for example - Shandong Hongyu Precision Machinery has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Shandong Hongyu Precision 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.