Shaanxi Fenghuo Electronics Co., Ltd. (SZSE:000561) shareholders are no doubt pleased to see that the share price has bounced 25% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 27% in the last twelve months.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 31x, you may consider Shaanxi Fenghuo Electronics as a stock to avoid entirely with its 61.6x 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 example, consider that Shaanxi Fenghuo Electronics' financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Shaanxi Fenghuo Electronics would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 32% 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 22% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 41% 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 Shaanxi Fenghuo Electronics' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Bottom Line On Shaanxi Fenghuo Electronics' P/E

The strong share price surge has got Shaanxi Fenghuo Electronics' P/E rushing to great heights as well. 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.

We've established that Shaanxi Fenghuo Electronics 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 2 warning signs for Shaanxi Fenghuo Electronics that you need to take into consideration.

If these risks are making you reconsider your opinion on Shaanxi Fenghuo Electronics, 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.