With a price-to-earnings (or "P/E") ratio of 49.2x Gansu Dunhuang Seed Group Co.,Ltd. (SHSE:600354) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 33x and even P/E's lower than 20x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Gansu Dunhuang Seed GroupLtd has been doing very well. It seems that many are expecting the strong 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 might be a little nervous about the viability of the share price.

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

The only time you'd be truly comfortable seeing a P/E as high as Gansu Dunhuang Seed GroupLtd's is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 53% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Gansu Dunhuang Seed GroupLtd's 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. 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 Key Takeaway

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 Gansu Dunhuang Seed GroupLtd 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.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Gansu Dunhuang Seed GroupLtd with six simple checks.

If you're unsure about the strength of Gansu Dunhuang Seed GroupLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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