Jiangxi Hongdu Aviation Industry Co., Ltd. (SHSE:600316) shareholders that were waiting for something to happen have been dealt a blow with a 30% 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 49% share price drop.

Even after such a large drop in price, Jiangxi Hongdu Aviation Industry may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 78.3x, since almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Recent times have been quite advantageous for Jiangxi Hongdu Aviation Industry as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be 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 Jiangxi Hongdu Aviation Industry?

In order to justify its P/E ratio, Jiangxi Hongdu Aviation Industry would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 34% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 24% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 42% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Jiangxi Hongdu Aviation Industry'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. 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.

What We Can Learn From Jiangxi Hongdu Aviation Industry's P/E?

A significant share price dive has done very little to deflate Jiangxi Hongdu Aviation Industry'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 Jiangxi Hongdu Aviation Industry currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Jiangxi Hongdu Aviation Industry you should be aware of.

You might be able to find a better investment than Jiangxi Hongdu Aviation Industry. 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.