Gansu Guofang Industry & Trade (Group) Co., Ltd. (SHSE:601086) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Gansu Guofang Industry & Trade (Group) as a stock to potentially avoid with its 40.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

For instance, Gansu Guofang Industry & Trade (Group)'s receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Gansu Guofang Industry & Trade (Group)?

In order to justify its P/E ratio, Gansu Guofang Industry & Trade (Group) would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 64% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 45% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

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 Gansu Guofang Industry & Trade (Group) 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. 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.

What We Can Learn From Gansu Guofang Industry & Trade (Group)'s P/E?

Gansu Guofang Industry & Trade (Group)'s P/E is getting right up there since its shares have risen strongly. 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 Gansu Guofang Industry & Trade (Group) 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.

Before you take the next step, you should know about the 3 warning signs for Gansu Guofang Industry & Trade (Group) that we have uncovered.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.