Guangdong High Dream Intellectualized Machinery Co., Ltd. (SZSE:300720) shareholders that were waiting for something to happen have been dealt a blow with a 25% 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 26% share price drop.

Although its price has dipped substantially, Guangdong High Dream Intellectualized Machinery's price-to-earnings (or "P/E") ratio of 59.1x might still make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 17x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Guangdong High Dream Intellectualized 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Guangdong High Dream Intellectualized Machinery?

In order to justify its P/E ratio, Guangdong High Dream Intellectualized 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 43%. This means it has also seen a slide in earnings over the longer-term as EPS is down 47% in total over the last three years. 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 41% shows it's an unpleasant look.

With this information, we find it concerning that Guangdong High Dream Intellectualized Machinery is trading at a P/E higher than the market. 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 Final Word

Even after such a strong price drop, Guangdong High Dream Intellectualized Machinery's P/E still exceeds the rest of the market significantly. 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 Guangdong High Dream Intellectualized Machinery 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. 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.

Having said that, be aware Guangdong High Dream Intellectualized Machinery is showing 2 warning signs in our investment analysis, you should know about.

If you're unsure about the strength of Guangdong High Dream Intellectualized 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.