Shenzhen SDG Service Co.,Ltd. (SZSE:300917) shares have retraced a considerable 26% in the last month, reversing a fair amount of their solid recent performance. Still, a bad month hasn't completely ruined the past year with the stock gaining 52%, which is great even in a bull market.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may still consider Shenzhen SDG ServiceLtd as a stock to avoid entirely with its 51.3x 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.

Earnings have risen at a steady rate over the last year for Shenzhen SDG ServiceLtd, which is generally not a bad outcome. It might be that many expect the reasonable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Shenzhen SDG ServiceLtd's Growth Trending?

In order to justify its P/E ratio, Shenzhen SDG ServiceLtd would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 3.0% last year. Still, lamentably EPS has fallen 11% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 36% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shenzhen SDG ServiceLtd is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

Shenzhen SDG ServiceLtd's shares may have retreated, but its P/E is still flying high. 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 Shenzhen SDG ServiceLtd 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.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Shenzhen SDG ServiceLtd that you should be aware of.

You might be able to find a better investment than Shenzhen SDG ServiceLtd. 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.

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