Guangzhou Devotion Thermal Technology Co., Ltd. (SZSE:300335) shareholders have had their patience rewarded with a 38% share price jump in the last month. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 4.0% over the last year.

Following the firm bounce in price, Guangzhou Devotion Thermal Technology's price-to-earnings (or "P/E") ratio of 44x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 33x and even P/E's below 20x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, Guangzhou Devotion Thermal Technology'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Guangzhou Devotion Thermal Technology's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. As a result, earnings from three years ago have also fallen 6.2% 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 37% 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 alarming that Guangzhou Devotion Thermal Technology'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. 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.

The Key Takeaway

Guangzhou Devotion Thermal Technology's P/E is getting right up there since its shares have risen strongly. 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 Guangzhou Devotion Thermal Technology 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Guangzhou Devotion Thermal Technology (1 is significant!) that you need to take into consideration.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.