Dragon Rise Group Holdings Limited (HKG:6829) shareholders are no doubt pleased to see that the share price has bounced 41% in the last month, although it is still struggling to make up recently lost ground. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 60% share price drop in the last twelve months.

Following the firm bounce in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 10x, you may consider Dragon Rise Group Holdings as a stock to avoid entirely with its 18.9x 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.

As an illustration, earnings have deteriorated at Dragon Rise Group Holdings over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Growth For Dragon Rise Group Holdings?

In order to justify its P/E ratio, Dragon Rise Group Holdings would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 47% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 22% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Dragon Rise Group Holdings is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

The strong share price surge has got Dragon Rise Group Holdings' P/E rushing to great heights as well. 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 Dragon Rise Group Holdings currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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.

You need to take note of risks, for example - Dragon Rise Group Holdings has 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.