The Zhejiang Runyang New Material Technology Co., Ltd. (SZSE:300920) share price has fared very poorly over the last month, falling by a substantial 27%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 14% in that time.

In spite of the heavy fall in price, Zhejiang Runyang New Material Technology's price-to-earnings (or "P/E") ratio of 48.1x 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. 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 Zhejiang Runyang New Material Technology's financial performance has been poor lately as its earnings have been in decline. 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 Zhejiang Runyang New Material Technology?

In order to justify its P/E ratio, Zhejiang Runyang New Material Technology 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 11%. As a result, earnings from three years ago have also fallen 80% 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 41% 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 Zhejiang Runyang New Material Technology's 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. 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.

What We Can Learn From Zhejiang Runyang New Material Technology's P/E?

Even after such a strong price drop, Zhejiang Runyang New Material Technology's P/E still exceeds the rest of the market significantly. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Zhejiang Runyang New Material Technology 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhejiang Runyang New Material Technology (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

Of course, you might also be able to find a better stock than Zhejiang Runyang New Material Technology. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.