The Ningbo Kangqiang Electronics Co., Ltd (SZSE:002119) share price has fared very poorly over the last month, falling by a substantial 25%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 23% 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 Ningbo Kangqiang Electronics as a stock to avoid entirely with its 57.3x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Ningbo Kangqiang 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.

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 Ningbo Kangqiang Electronics' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 58% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 24% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

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 Ningbo Kangqiang Electronics' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Key Takeaway

Even after such a strong price drop, Ningbo Kangqiang 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.

We've established that Ningbo Kangqiang Electronics currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Ningbo Kangqiang Electronics you should know about.

You might be able to find a better investment than Ningbo Kangqiang Electronics. 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.