The ZHEJIANG DIBAY ELECTRIC CO.,Ltd. (SHSE:603320) share price has fared very poorly over the last month, falling by a substantial 32%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 19% share price drop.

Even after such a large drop in price, ZHEJIANG DIBAY ELECTRICLtd may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 56.2x, since almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 17x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at ZHEJIANG DIBAY ELECTRICLtd over the last year, which is not ideal at all. 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.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, ZHEJIANG DIBAY ELECTRICLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 47% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 34% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

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 ZHEJIANG DIBAY ELECTRICLtd 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 Key Takeaway

A significant share price dive has done very little to deflate ZHEJIANG DIBAY ELECTRICLtd's very lofty P/E. 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 ZHEJIANG DIBAY ELECTRICLtd 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. 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.

It is also worth noting that we have found 5 warning signs for ZHEJIANG DIBAY ELECTRICLtd (1 is a bit concerning!) that you need to take into consideration.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.