China MeiDong Auto Holdings Limited (HKG:1268) shareholders that were waiting for something to happen have been dealt a blow with a 31% share price drop in the last month. For any long-term shareholders, the last month ends a year to forget by locking in a 78% share price decline.

Although its price has dipped substantially, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may still consider China MeiDong Auto Holdings as a stock to avoid entirely with its 19.2x P/E ratio. 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.

China MeiDong Auto Holdings could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

In order to justify its P/E ratio, China MeiDong Auto Holdings 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 74%. As a result, earnings from three years ago have also fallen 83% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 87% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 16% per year, which is noticeably less attractive.

In light of this, it's understandable that China MeiDong Auto Holdings' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

China MeiDong Auto Holdings' shares may have retreated, but its P/E is still flying high. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that China MeiDong Auto Holdings maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Having said that, be aware China MeiDong Auto Holdings is showing 2 warning signs in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than China MeiDong Auto Holdings. 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.

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