Shenzhen Mingdiao Decoration Co.,Ltd. (SZSE:002830) 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 19% in that time.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Shenzhen Mingdiao DecorationLtd as a stock to avoid entirely with its 69.9x 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 instance, Shenzhen Mingdiao DecorationLtd'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.

Does Growth Match The High P/E?

Shenzhen Mingdiao DecorationLtd's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 34% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 12% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the market, which is expected to grow by 41% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Shenzhen Mingdiao DecorationLtd 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 Bottom Line On Shenzhen Mingdiao DecorationLtd's P/E

A significant share price dive has done very little to deflate Shenzhen Mingdiao DecorationLtd's very lofty P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen Mingdiao DecorationLtd (at least 1 which is potentially serious), and understanding these should be part of your investment process.

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

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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.