The Nanjing Xinjiekou Department Store Co., Ltd. (SHSE:600682) share price has done very well over the last month, posting an excellent gain of 25%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 25% in the last twelve months.

In spite of the firm bounce in price, you could still be forgiven for feeling indifferent about Nanjing Xinjiekou Department Store's P/E ratio of 30.2x, since the median price-to-earnings (or "P/E") ratio in China is also close to 28x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

For example, consider that Nanjing Xinjiekou Department Store's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Does Growth Match The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like Nanjing Xinjiekou Department Store's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 59% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 71% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

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.

In light of this, it's somewhat alarming that Nanjing Xinjiekou Department Store's P/E sits in line with the majority of other companies. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

The Final Word

Nanjing Xinjiekou Department Store's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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 Nanjing Xinjiekou Department Store currently trades on a 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 moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 2 warning signs for Nanjing Xinjiekou Department Store (1 shouldn't be ignored!) that you need to take into consideration.

You might be able to find a better investment than Nanjing Xinjiekou Department Store. 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.